Business Organizations Book Outline

Chapter 1: Introduction
1.02 The Menagerie of Business Associations
A. Brief Overview of Unincorporated Business Forms
Traditional Business Structures
1. Sole Proprietorships
Individually ran;
No legal organization required;
2. Partnerships
An association of two or more persons, to carry on as co-owners a business, for a
profit.
They dont have to do anything else (file paperwork, etc), but they must operate under
the assumption that they are a partnership. Can simply be an understanding.
joint proprietorship
Owners have personal liability for all obligations, voluntary and involuntary.
3. Corporations
More than an informal business;
Requires filings;
Creates a liability shield as a matter of the default rule, and has other attributes that are
governed by corporate statutes.
Downfalls: expensive; double taxation.
Non-Traditional Business Structures
4. Limited Partnerships
5. Limited Liability Partnerships
6. Limited Liability Companies
Through state legislatures creating new forms via statute, there are new
unincorporated associations that offer the limited liability aspect of a corporation.
Limited Liability helps companies get investors.
B. The Functions of Business Association Statutes
Firms can contract around most statutory provisions, even in the traditional corporate
form.
Statutes provide standard forms in order to economize on contracting costs;
however, forms are not statutes.
If the firm is relatively small, the forms can benefit by saving drafting costs.
Problem with forms is they are off the rack and not tailored to each individual
business need.
C. Linking Statutory Forms
Courts battle with whether statutory rules should be linked.
1

Business Organizations Book Outline

i.e. General and limited partnership cases can apply to limited liability companies and
limited liability partnerships.
Linkage may defeat the purpose of having separate forms.

D. Choice of Business Form

Firms must decide whether default rules fit its particular circumstances, taking into
account how each business form will be taxed and regulated.
E. Choice of Law and Uniformity
Choice of form is closely related to choice of law.
State variations in law matter, especially with limited liability companies and limited
liability partnerships where there is the most variation.
In contrast to corporations, partnerships and unincorporated firms could not always
choose the applicable law so easily.
Choice of law was not much of an issue for partnerships because for most of the
century state law has united around the Uniform Partnership Act (1914) and the
Uniform Limited Partnership Acts (1916, 1976, 1985)these acts now have 1997 and
2001 versions.
Limited Liability Company, Limited Liability Partnerships, and most limited
partnership statutes now include specific provisions recognizing foreign firms of the
same type and applying laws under which those firms are organized. The revised
version of the UPLA includes a choice-of-law provision.
F. Business Associates as Aggregates and Entities
Corporations have traditionally been regarded as a separate legal entity that has
rights, powers and liabilities separate from the owners.
o Corporations also continue after the withdrawal or death of an owner.
Ownership of property, prosecution and defense litigation is in the name of the
corporation and not the owners.
Partnerships are aggregates of the owners.
o Partners in partnerships are personally liable for the debts of the firm.

1.03 Tax Considerations

Partnerships are taxed in a flow through manner. Meaning income and perhaps
losses are taxable directly at member level rather than first at the level of the firm.
Corporations are taxed doubletaxed at the entity level and when they distribute
dividends.

1.04 Attorneys Role

When advising clients, attorneys want to consider: choice of law, tax implications,
transaction costs, and interests of the parties, default rules, agency costs, etc.
To establish a default rule, consider what the parties would have agreed to without a
law in place.
Chameleon Agreement is a broad shell to begin with when drafting.
2

Business Organizations Book Outline

Chapter 2: The Search for the Incorporated Partnership

2.01 Introduction
LLCs have been the on the rise for the past 20 years.
General Partnerships are well suited for closely held firms, but LLCs offer limited liability.
Partnership statutes provide by default rules for owner-managers would ordinarily want including: direct
member participation in management, equal allocation of financial rights, restricted transferability of
management rights, and the ability to leave the firm via dissolution or buyout.
o Can be easily altered by the partnership agreement to suit different variations.
Before the rise of LLCs, people received general liability by contracting under state corporate laws.
Corporate shareholders are only at risk for what theyve invested in the firm and not otherwise liable for
corporate activities.
The problems between choosing a corporation or a partnership have led to the rise of incorporated
partnershipsbusiness forms that combine partner-type governance rules with limited liability. However,
the incorporated partnerships didnt solve all the problems.

2.02 Corporate Governance and The Closely Held Firm

A. Corporate Default Rules
Corporate statues arent good for closely held firms.
Closely held means firms that combine (1) owners direct participation in management; (2) restricted
transferability of management rights; and (3) a lack of a public market for the firms shares.
Management

Shareholder voting

Partnerships
Equal participation in
management decisions.
Partners can delegate power to
managers, but it is not
typically the power that a
board of directors has.

Corporations
Managed by or under the
board of directors. This
extends to day-to-day activities
as well as the ability to declare
dividends.
Shareholders select the
directors and make the
important decisions, i.e.,
amending the articles of
incorporation, merger, sale of
all or substantially all of the
corporations assets and
dissolution.
Shareholders lack both actual
and apparent authority to
create corporate liabilities.
Shareholders dont participate
in the day-to-day activities.
Board of directors hires
officers (P, VP, T, S, etc)

One vote per partner. Votes

reflect partners multifarious
service, capital, and credit
contributions, as well as being
consistent with the partners

Shareholders have one vote per

share. Usually shares are
bought with cash, therefore
voting power is effectively
allocated in proportion to

Business Organizations Book Outline

Transferability

Dissociation and Dissolution

ultimate personal liability for

the obligation of the business.
Partners can only transfer
financial rights and veto
admission of new partners.
Closely held firm owners will
want to be able to determine
identity of co-managers that
have important rights to create
liabilities that can cause the
owners to be personally liable.
Default rule is that partners
can compel the firm to
liquidate, or at least buy out
their interests, at any time.
This provides some liquidity
for non-transferable
partnership interests.

capital investments.

Shareholders can sell their

complete bundle of ownership
in the firm, including
management and financial
rights (usually). This is
regarded as a basic property
right.

Corporate entities survive

while those who own interests
in the entities may come and
go.
Corporations can normally
only be dissolved by majority
vote of shareholders after a
director resolution.

B. Waiver of Corporate Defaults

Corporate laws were traditionally not subject to any contrary agreement and the courts took this literally.
Overtime, the laws evolved.
Corporate law began to change with judicial loosening of statutory rules and eventually statutory change.
Courts have quickly accepted the principle that shareholders may enter into enforceable contracts to alter the
manner that shareholders exercise their right to vote.
o Ringeling v. Ringling Bros-Barnum & Bailey Combined Shows Inc.- upheld an agreement enforcing
shareholder voting agreement that effectively gave disproportionate power to minority shareholders.
o McQuade v. Stoneham- Recognized the power of shareholders to unite by agreement to elect directors.
Courts are slower to recognize or authorize shareholders to contract regarding management matters that are
traditionally within the purview of the board of directors.
o Clark v. Dodge- enforcing director control agreement giving substantial power to shareholder where
there were no non-party shareholders and the board retained some power.
Some variations were only permitted for close corporationsusually defined in terms of some number of
shareholders, absence of a public offering or listing on a securities exchange, and use of stock transfer
restrictions.
o If shareholders elect to enter into an agreement that is only enforceable in close corporations but fail
to elect or qualify that it is a closely held corporation, courts might enforce the agreement anyways.
C. Filling The Gaps
The issue is what default rules should fill the gaps of parties contracts.
Most people that just want limited liability in a closely held firm do a bare bones incorporation, without
consulting a lawyer, which is a form that doesnt fit their needs.
Legislatures answered this by enacting close corporation dissolution and buy out remedies. These require
partners to say why they need to leave or that they are oppressed. Courts look for the parties reasonable
expectations.
TAKEAWAY: Drafting is important and parties have several concerns to take into account before choosing a form.

2.03 Double Taxation and The Corporation

Business Organizations Book Outline

Corporations
Corps that are subject to Subchapter C of the Internal Revenue Code is taxed on profits that they earn at the
corporate rate. Shareholders are taxed only when distributed dividends. Shareholders can get taxed on their
gains when they sell shares even if there are no dividends.
Corporations that lose money do not get a substantial tax break unless they can carry the loss back to
previous years. Shareholders that incur capital losses when selling their shares may be able to deduct these
losses against their capital gains.
When Corporate and Capital gains taxes are low and personal tax rates are high, firms can shelter income
by letting it build up in the corporation, while owners can cash the returned earnings by selling shares.
Subchapter S corporations can get some benefits of partnerships. Income and losses in a subchapter s
corporation flow through to share holders almost like a partnership. Subchapter S corporations can only
be filed in a limited amount of circumstances.
Partnerships
Profits are earned for tax purposes directly by the partners. Taxed only once a year, to the partners, at the
partners individual tax rate, and not again when they are distributed to the partners.
Partners may be able to deduct partnership losses against their non-partnership income, a.k.a. sheltering
income. This is become less easy. Partners cannot deduct passive losses that they incur from firms that they
do not manage.

2.04 The Evolution of Unincorporated Limited Liability Firms

Erosion of tax restrictions helped revolutionize the choice between corporations or partnerships for firms
that wanted the benefits of limited liability, but didnt necessarily fit under the corporate structure.
Whether a business is taxed as a corporation or a partnership is usually determined by the following
definitions in the Internal Revenue Code:
o Corporation- includes associations or businesses that resemble corporations even if they have not
actually been organized pursuant to state corporate law.
Thus, a firm cant claim to be a partnership and operate as a corporation to avoid taxes, they
will be taxed as a corporation regardless of their form.
For many years, treaties determined what was an association via the Kitner Rules. (United
States v. Kitner, IRS concerned with stopping what it believed were essentially partnerships
from attaining certain tax advantages of incorporation, including the ability to shelter
income in corporate pension plans.). see below
o Partnership- residual category which includes most of what is not corporate, trust, or estate.
Kitner Regulations: judged corporate resemblance in terms of what the IRS believed to be the
distinguishing characteristics between corporations and partnerships. To be considered a corporation for tax
purposes, the company had to have at least three of the following characteristics:
o (1) continuity of life,
o (2) corporate-type management,
o (3) limited liability,
o (4) free transferability of interests.
Check the Box Rule: Recognizing relative problems with the Kitner rules, the IRS adopted a rule that
drops the four-factor approach; in favor of letting unincorporated firms choose whether to be taxed
as either corporations or partnerships.

Business Organizations Book Outline

o This rule provides that a domestic eligible entity, which includes business firms other than
corporations, joint stock companies, insurance companies, or banks, is not treated as a corporation
for tax purposes unless it chooses to be.

2.05 Recurring Themes of Unincorporated Liabilities

Publicly held incorporated firms: there are several publicly traded unincorporated firms. This shows that
choice of form does not neatly divide between closely and publicly held. Sometimes publicly held firms
might want to adopt features of limited partnerships and limited liability companies.

Business Organizations Book Outline

Chapter 3: Forms and Formation of Unincorporated Entities

3.02 Sole Proprietorship
Not an actual business form, rather a single owner who operates a business. Does not
require ANY legal steps to form.
Owners are personally liable to all creditors and for debts incurred by the business.
Owner takes all returns of the business after creditors are paid.
Owner hires capital, supplies, and labor by employment, lease, and loan agreements.
Sole owners can contract with people to lend money. What if inputs are required from
others? What constitutes the firm and what constitutes a separate entity with which the
firm is doing business? This can be explained with agency law.
The Firms and agents differ fundamentally from contracts the firm makes with those
outside it, i.e. third parties.
Agents vs. Third Parties:
Agents
Agents are bound to act on behalf of the firm.
The law of agency governs the legal relationship implicit in one person doing
something on behalf of another person. However, sole proprietorship owners can
engage an agent or lender without sharing profits, but the owner bears all the liability
and risk of loss in the business, not the agent.
Third Parties
Third Parties (customers, supplies, etc) act in their own interests, subject to discrete
contractual provisions established between the firm and the third party.

3.03 Partnership
A. Application of Partnership Default Rules
Default characterization is two or more people operate and share the risks of the
business. Could be referred to as a joint proprietorship
Sole proprietorships can become partnerships without the parties ever discussing or
filling out paperwork.
Uniform Partnership Act (UPA) applies unless waived by a contrary agreement
between the partners.
Although there is a revised version of the UPA, RUPA 1997, 13 states still adopt the
UPA thus a major concern for partnerships is what state to contract in depending on
which act would benefit their partnership the most.
Partners liability as co-principals is the most important consequence of being in a
partnership. Several implications arise:
1. Partnership law makes each partner a co-manager with an equal vote on all
matters and a power to veto important decisions and amendments to the
agreement. (See Ch. 4).
2. Equal sharing of revenues and expenses or profits and losses. (Ch. 5).
3. Vicariously liable for the obligations of the partnership. (Ch. 6).
4. No single partner may deal with partnership property as their own, but may use
the partnership property only for the firms benefit. (Ch. 7)

Business Organizations Book Outline

5. Each partner is entitled to veto the admission of new partners and therefore
cannot transfer their management rights or partner statues without the other
partners consent. (Ch. 7).
6. Partners have fiduciary obligations to the partnership and to each other. (Ch. 8)
7. Since partners cant sell out to third parties to leave the firm, their are other
escape mechanismsthe power to disassociate and be bought out or dissolve
the firm and put it up for sale. (Ch. 9)
Parties can contract around a lot of the default rules; however, they may NOT:
1. Unreasonably restrict a partners access to books and records of the
partnership;
2. Eliminate the general duty of loyalty (although specific exceptions may be
approved)
3. Unreasonably reduce the duty of care;
4. Eliminate the obligation f good faith and fair dealing (although certain
reasonable standards by which this performance of this duty is measured may
be established);
5. Vary the power of a partner to dissociate;
6. Vary the right of a court to expel a partner under specific circumstances; or
7. Restrict the rights of third parties under the RUPA.

B. Existence of Partnerships
Corporations, limited partnerships, and LLCs require a filing of paperwork; however,
partnership is a legal characterization based on objective intent that may or may not
comport with the partners subjective intention. Partners just have to act in a manner
that resembles a partnership and they become a partnership in the eyes of the law.
o Subjective intent- courts look to see if partners made statements/ formalized
agreements or engaged in conduct indicating that they thought they were coprinciples. Subjective intent is relevant, but not dispositive under the objective
test.
o Just because a contract provides that partners agree to the default rules, it does
not necessarily follow that the parties want other partnership default rules as
between the partners to apply. Partners can contract around the default rules;
however, default rules with respect to third parties are more difficult to contract
around.

Look for difficult cases when the parties are in a business as husband and wife/
debtor/creditor. It becomes difficult to discern whether the parties are co-owners
in situations like those.
When parties act like partners, courts should look to see if they are sharing profits
(UPA 7). If profit-sharing exists, it is presumptively a partnership unless it fits under
the specific categories listed in UPA 7(4) and RUPA 202(c)(3).
UPA 7: the share of profits of a business is prima facie evidence that there is a
partnership, unless the funds are received:
a) as a debt by installments or otherwise;
b) as wages of an employee or rent to a landlord;
c) as an annuity to a widow or representative of a deceased partner,
d) as interest on a loan, though the amount of payment vary with the profits of the
business;

Business Organizations Book Outline

e) as the consideration for the sales of the good-will of a business or other

property by installments or otherwise.
If the relationship is one of the specific categories, the profit-sharing drops out of the
case and the court weight evidence against other evidence of objective and subjective
intent.

In Re Marriage of Hassiepen, 269 Ill. App.3d 559, 646 N.E.2d 1348 (1995) (Pg. 25)
HUSBAND/WIFE CASE.
FACTS: Petitioner, Cynthia, filed to increase child support payments after she and
Kevin got a divorce. Kevin and his wife Brenda started an electrician business and
subsequently became very wealthy. Brenda put up the money to start the business and
Kevin put in the physical work/does the manual labor while Brenda manages the day
to day activities.
ISSUE: The issue here is that Kevin and Brenda argue they are in a partnership and
Cynthia argues that they are. If they are in a partnership, only half of the income is
calculated for Kevins child support, whereas if they are not engaged in a partnership,
the full income is used and Kevin would have to pay more.
Objective facts: evidence shows they acted as partners: Brenda started the business
on her credit card; she wasnt paid anymore for her services to the partnership; joint
checking account; actions of each Brenda and Kevin; profit sharing, or at lease they
both have access to the profits in one accountthis cuts against Cynthias claim.
Subjective facts: Kevin put on his tax returns that it was a sole proprietorship.
Brendas name was not on any legal documents or deeds; Brenda held a job as a court
reporter and filed separate tax returns for that job; Brendas name is not on any
business cards; their accountant doesnt know their in a partnership; In interrogatories
Kevin referred to Brenda as his employee.
The also consider:
o Theyre not sophisticated parties;
o The wishy-washy attitude of Kevinhe claimed they were a partnership until
he realized it would cut against his money;
o Equity issueif they werent married/living together, then maybe the
relationship would be viewed wrong. The court looks to the objective factors
that really say theyre in a partnership. The subjective intent does cut against
their argument.
HOLDING: The court follows the objective intent and finds a partnership between
Kevin and Brenda. Court finds that partnerships are a question of intent.
Analysis: Maybe Cynthia was already getting a substantial amount of money. Court
doesnt find this as manipulation; they find it as lack of education. The objective intent
in reality is clear and comfortable with the partners. The Court does not believe Kevin
and Brenda tried to manipulate the system.
--s
Martin v. Peyton, 246 N.Y. 213, 158 N.E. 77 (1927) EX OF DEBTOR/CREDITOR CASE
KNK, a partnership, needed money and no one would loan to them. Hall, a partner
there, arranged for the defendant (Peyton + others) to loan $2.5 million in marketable
securities to KN&K. In the agreement, the investors were to receive 40% of the firms

Business Organizations Book Outline

profits until the return is made, but nor more than $500,000.00. They also had an
option to buy equity, inspect the books, and veto rights of new partners.
Given KNKs financial status, the investors took protective measures:
o Creditors had the option of reviewing books; partners had to provide letters of
optional resignation so that if they speculated poorly, PPF could terminate their
employment; PPF required that their friend, Hall, be in control and also put a
life insurance policy on him for $1 million (KEY PROVISION).
o One of the restrictions was a foreign currency speculationthey speculated on
foreign currency and that is why the case was filed.
When KNK filed bankruptcy, a creditor sued PPF, alleging that they were a partner
and thus liable for all of KNKs debts..
ISSUE: Is this a partnership?
o In one instance, they subjectively call it a loan and explicitly state that it is not
a partnership, but the objective inferences make this look like more, i.e. the
control aspects that PPF received.
o This is a major issue because under UPA 15, 40 outside creditors get paid
first. If PPF is a partner, theyre liable for the debts being sought, but they also
get a portion of what is left after the creditors collect.
HOLDING: Not a partnership. Court says that this is a loan which is one of the
specific exceptions under UPA 7.
ANALYSIS: If they intended to be partners, they would have voiced it and taken a
management role. The manner it was structured indicates a partnership; however, not
enough evidence. Court says there is overlap, but not enough to deem this a
partnership.
TAKEAWAY: Division of profits does not always equal partnership. In a law
firm, some associates receive bonuses, etc that comes out of profits, but this does
not deem the associate a partner. You can give profits to people without them
necessarily becoming partner. Also, the court notes that the control issues here
are typical of smart investors.
UPA 40: In settling accounts between the partners after dissolution, the liabilities of the
partnership shall rank in order of payment:
1) those owing to creditors other than partners;
2) those owing to partners other than for capital and profits.
-subordinates loans by partners.
UPA 15: All partners are liable:
a) jointly and severally for everything chargeable to the partnership under 13 and 14
eg. Torts and breaches of fiduciary duty;
b) jointly for all other debts and obligations of the partnerships.
eg. Contracts
Minute Maid Corps v. United Foods, Inc., 291 F.2d 577 (5th Cir.), cert denied, 368 U.S. 928
(1961)supplier/creditor partnership
FACTS: Here, several relationships exist. Minute Maid and United Foods have a
relationship to distribute and store frozen juice. Cold Storage and United enter into an
agreement whereby Cold Storage provides United with additional storage. United

Business Organizations Book Outline

gives Cold Storage a 6% note (this allows them to speculate the food market and buy
in bulk to receive discounts). A special account between Cold and United was created.
At all times, Cold Storage owned and operated the storage facility that United used to
store Minute Maids products. Cold Storage had the facilities and also the capital to
help United purchase the bulk qualities from Minute Maid.
According to the agreement, United Foods and Cold Storage were the parties. The
agreement didnt leave room for differentiation. This is a drafting problem. It creates
potential problems with contracts. Cold Storage tried to argue that this was merely a
creditor/debtor relationship where United paid them for storage.
Was there anything that showed intent to form a partnership?
o OBJECTIVE: United foods wanted to buy more from Minute Maid at a lower
price, but they couldnt afford to do so without the bulk discount. Cold storage
had the facilities to store it and the money. It was clear that the arrangement
was set up to take advantage of the situation.
o SUBJECTIVE: no shared phone number, emails, etc. Reference to the UUS
agreement in undertaking. There is nothing that shows them to be
holding/acting as partners.
Only the objective intent looks like a partnership. Subjective intent is not compelling.
When businesses go into joint ventures, they usually state it and name the venture.
Here, the companies are just working together to achieve the most efficient outcome
not a partnership.
HOLDING: Court finds a partnership here and a creditor/debtor relationship.
o Control over the enterprise was jointly held by United and Cold Storage.
It was the arrangement whereby Cold Storage furnished the financing and
warehouse facilities to make possible Uniteds use of its relationship as a direct
buyer of Minute Maid products in such quantities and under such terms as
would turn a profit for both of them.
o The parties had joint control over the enterprise. United initially determined
how much to buy from Minute Maid, but such determination was subject to
Cold Storages right to determination whether the proposed collateral would be
acceptable. United also testified that Cold Storage could have stepped in and
written them off quickly.
ANALYSIS:
o Court observes that the brokerage business is very large and generates
significant amounts of money.
o Court leads you to believe that this is a partnership, but the arguments against
it:
If they were a partnership, they wouldnt be paying for the others
services, theyd be receiving them for free.
Minute Maid found out about this arrangement only before the lawsuit
commenced. United Foods didnt pay; Cold Storage is a partner
(allegedly) so they sued.
o Partnerships typically do things differently. Here, Cold Storage explicitly states
that theyre only liable for the ventures with minute maid.
Whether or not the security measures amounted by themselves to control of the
partnership affairs, the operation here was clearly within the joint control of the
parties.

Business Organizations Book Outline

NOTE 3-2
Subjective vs. Objective:
o Subjective intent alone may be controlling where the parties agreement
explicitly states the relationship as either a partnership or non-partnership (as
in Martin).
o Parties explicit characterization may be ambiguous despite the use of the word
partner.
o Sometimes partners may clearly subjectively intend to be partners, but theyre
not clear as to what being partners means.
Partnership characterization and third parties:
o Regardless of what the parties call themselves, if theyre acting like a
partnership, they are a partnership. Conversely, if they claim to be a
partnership, but act otherwise, they are not considered a partnership. The
reason the rules do this is for third parties. Provisions reject a quantum
theory of partnership in which the firm may be simultaneously a partnership
and a non-partnership, depending on who looks at it.
o It makes some sense that an agreement between supposed partners who style
themselves as such bears the ultimate objective determination whether or not
they will be deemed to be partners as to third parties, particularly in close
cases.
Objective indicia of partnership:
o The objective intent can be weighed for and against the partners.
The importance of profit sharing:
o Agents are required to act at the control of their principals. Partners share
control so this factor is more ambiguous in a partnership than an agencyrelationship.
o Profit sharing is an important indicator of a partnership b/c it strongly suggests
that the parties would want the default partnership rules to apply. Also there is
incentive to act for the good of the partnership when youre sharing profits and
losses.
What is profit sharing?
o Sharing gross revenues alone does not indicate partnership under the UPA and
RUPA because a gross-sharer, such as a salesperson working on a commission,
has no incentive to control expenses.
o It makes sense to make only sharing of profits in the traditional accounting
sense of net income, rather than any kind of benefit-sharing an indicator of
partnership.
Non-economic partners:
o Delaware Act allows partners admitted under specific provisions to be
admitted without an economic interest in the partnership.
o Sometimes partnerships are created between partners who do not intend to
share profits or have an economic interest in the partnership. The answers can
lye in the non-economic partners and also whether there was a violation of
professional ethics for representing someone as a partner when they werent.
Control

Business Organizations Book Outline

o Control is not as important for partnership as agency, but it is a good indicator

of partnership. Active participation in management may be a stronger indicator
of partnership than mere veto power.
Liability as risk-allocation
Loss-sharing
o Like profit sharing, loss sharing, strongly indicates the extent of the sharers
incentive to monitor the business.
Protected Relationships
o Certain profit-sharing relationships, such as debtor-creditor relationships
involved in Martin and Minute Maid are singled out in UPA and RUPA as not
being presumptive partnerships.
o People in relationships (like Hassippen) are likely to share profits without
wanting the other elements of a partnership, such a joint control.
Policy analysis: Loans as Partnerships
The role of the parties agreement
Partnership by estoppel
o Representations to third parties can make a non-partnership become a
partnership. The third party cant merely say he would have done something if
there was a partnership, there has to be reliance on the partnership.
o Types of representations that create estoppel:
Plaintiff billed on stationary which included defendants name in the
name of a professional association;
Law firm might be actual partnership although the firms letterhead
described it as professional association;
Doctors whose names were listed on a medical corporations office
door, appointment cards, and prescription pads, but used separate
receptionists, were not as a matter of law ostensible partners.
o Did the plaintiff rely on the fact that there was a partnership?
SJ granted for defendant because a plaintiff alleged that he relied not so
much on the defendant being a partner in a law firm, rather the
partnership being financially sound because it had malpractice
insurance.
When are office-sharing lawyers partners?
o Insurance policies that list all lawyers and letterheads that list all lawyers in the
office names are indicators of a partnership.
o Partnership by estoppel goes to whether the putative partners have made
representations, relied upon by third parties, making it inequitable for the
partners to deny the existence of a partnership in the first instance.
o Apparent authority is differentpresumes the existence of a partnership, and
deals with the question of whether the partners act binds the partnership, even
if actual authority did not exist.
A showing of apparent authority doesnt require representation or
subjective reliance. It depends on the objective reasonableness of a
creditors assumption that the partner is carrying on the business in the
usual way.
Other liability theories

Business Organizations Book Outline

o Morrison v. Labor- evidence was insufficient to show that the sole owner of
two corporations operating a house cleaning business was a partner of the
entities and therefore personally liable for a corporations unpaid
unemployment contributions. The facts may have justified piercing the
corporate veil, but the plaintiff did not allege that theory.
Opportunism
o Refers to the parties natural human inclination to seize opportunities for gain
that are permitted by the literal terms of the contract or by weak remedies or
mechanisms of enforcement.
Requirement of Writing
o Partnerships agreements do not have to be in writing. Statute of frauds
generally makes agreements that cannot be completed within a year
unenforceable if theyre not in writing.
o LLC require written filings.
Existence of partnership in the context of other law
Employment Discrimination
o Apply to partnership employment decisions regarding non-partner employees.
o There are significant differences between partners and employees, including
liability for loss, profit sharing, and selectivity of admission.
o Some use a bona fide partner test and only look to the states definition of a
partner.
o MUST LOOK BEYOND LABELS TO DETERMINE WHO IS A PARTNER.
o TEST ADOPTED BY SUPREME COURT:
1. Whether the organization can hire or fire the individual;
2. What extend the organization supervises their work;
3. Whether the individual reports to someone higher else;
4. If and to what extend the individual is able to influence the
organization;
5. Whether the parties intended that the individual be an employee, as
expressed in written contracts or agreements;
6. Whether the individual shares in the profits, losses, and liabilities of the
organization?
Federal securities law
o Security- broadly defined- any interest or instrument commonly known as a
security.
o It means any note, stock, bond, debenture, investment contract or, in general
any instrument commonly known as a security.
Investment contract: defined in SEC v. Howey: 1) a contract,
transaction, or scheme whereby a person invests money, (2) in a
common enterprise; (3) and is led to expect profits; and (4) solely from
the efforts of the promoter or a third party.
It is immaterial whether the shares in the enterprise are
evidenced by formal certificates or by nominal interests in the
physical assets employed by the enterprise.
The term security was intended to capture all cases where you
give money to someone else and receive a profit for what that
person does with the money.

Business Organizations Book Outline

o Applying the Howey test:
1. Investment of Money: This can be anything that constitutes
legal consideration for the purposes of contract law.
2. Common Enterprise: Horizontal commonality is shareholders in
a corporation. This satisfies the common enterprise requirement.
Vertical Commonality looks to the relationship between the
investor and the promoter of the scheme in a common
enterprise. Circuits are split whether vertical commonality
satisfies the common enterprise prong. 9th Circuit says that it is
sufficient, but it does not exist if the promoter got a fixed fee
irrespective of whether the investor made or lost money.
3. Expectation of Profits: Usually not very important. Even in
something like a tax shelter arrangement, there is an expectation
that some of the money will be shielded from taxes.
4. Solely from the efforts of others: Courts do not read this
literally. The critical inquiry is whether the efforts made by
those other than the investor are the undeniably significant ones,
those essential managerial efforts which affect the failure of
success of the enterprise.
o There are seven statutes, only two matter for us:
Securities Act of 1933regulates the offering and sale of new
securities.
Securities Exchange Act of 1934- regulates secondary market activity.
Created the SEC: independent agency; enforce the securities
laws and promulgates rules and regulations to implement those
laws more effectively.
o Generally, we look at the economic realities in a totality of the circumstances
to determine whether something is a security or not. Securities laws are
concerned with investments, not commercial ventures.
i.e. buying an entire gas station would not be a security. However,
buying a piece of it may be one.
o This is important for investors because it is likely that securities laws regulate
purchasing an interest in a firm.
o Securities laws require disclosure of certain information and they give the
procedural rules for some transactions:
Laws of incorporation: These give the rules for how the firm runs.
Fiduciary duties, voting rights, limited liability, and dissolution.
Internal Affairs Doctrine: State of incorporations laws dictate how we
deal with the internal affairs of the entity.
o Is an LLC or Partnership Membership Interest a Security?
Securities Act 2(a)(1): the term security means any investment
contract.
Application to General Partnerships
o All partners have equal rights to participate in
management

Business Organizations Book Outline

o All partners have informational rights (such as rights to
inspect books and records and to demand information)
o Some key decisions, such as admissions of new
members or acts in contravention of the partnership
agreement, require unanimous consent.
o All of these can be modified by contract in the
partnership agreement.
o Partnerships can be an investment contract when theyre
so dependent on a particular partner.
Application to Limited Partnerships
o Limited Partners have limited control rights
RULPA gives greater rights.
o Some courts therefore adopt per se rule that limited
partnership interests are not securities. However,
generally, limited partnership interests are securities.
Limited partners can exercise considerable de
facto control
Do we look solely at agreement at the outset or
at subsequent behavior?
Application to LLCs
o This is a closer call. It is very fact specific.
Member-managed: More like a general
partnership. This is generally not a security.
Manager-managed: More like a limited
partnership or corporation. Much more like a
security.
CRITICAL INQUIRY: Whether the powers possessed by the general partners in the
partnership agreement were so significant that regardless of the degree to which such powers
were exercised the investments could not have been premised on a reasonable expectation of
profits to be derived from the management efforts of others.

3.04 Limited Partnership

A. Background and History
Advantages of a partnership, but offer limited liability at least to some partners.
Initially used for tax shelters in oil and gas, real estate and other activities, the federal
income tax laws have changed, reducing the limited partnerships use.
Widely used today to raise capital for residential developments, buildings, medical
offices, and raw acreage. Also widely used as investment funds.
Statues developed:
o ULPA: intended to relieve the strictness of the first state statues. Included
provisions such as enforcing the liability shield with only substantial
compliance with formalities and allowing a partners contribution to be in
property rather than only in cash.
o RULPA:

Business Organizations Book Outline

(1976) narrowed the limited partners control liability by requiring
more participation in control and providing for a safe harbor of things
limited partners may do without taking part in control.
(1985) revised the 1976 version and most states have adopted this
version.
o ULPA 2001:
B. Overview
Three distinguishing characteristics:
1. Limited partnerships cannot arise merely from an after-the-fact characterization.
Limtied partnerships only come about because parties deliberately file paperwork
with the state indicating their subjective intent.
2. We expect to be dealing with an express agreement rather than the default rules
since limited partnerships are intentional
3. LPs usually involve promoters securing passive financing from investors rather
than co-management by the partners.

Limited Liability
Must have at least one general partner whose rights and duties are those of a general
partner in a general partnershipincluding a general partners vicarious liability for
the partnership obligations.
The rest of the partners may be limited in the sense that they have limited liability
subject to statutory provisions primarily aimed at protecting creditors.
Financial rights
The default rule is that right to participate in returns and the obligation to share in
losses is based upon the value of the partners contributions, as reflected in the records
of the limited partnership. This should be laid out in the partnership agreement.
Limited partner passivity
LP provides safe harbor for people seeking to be more than a creditor but something
less than fully participating in general partner.
Limited partners are passive: while they have voting rights as to certain fundamental
matters, they are subject to being deemed general partners if they actively participate
in the management of the firm.
ULPA 2001 eliminates the control rule.
Fiduciary duties and remedies
LPs have no fiduciary duties to other partners or the partnership solely by reason of
being a limited partner. With the elimination of the control rule in ULPA 2001, limited
partners could take on management responsibilities, but in that case they would have
fiduciary obligations.
RULPA and ULPA have a derivative action remedy by which limited partners may sue
the general partner on behalf of the partnership.
Withdrawal, dissociation, and dissolution
RULPAo general and limited partners have the right to withdraw, rightfully or
wrongfully, and receive distributions upon withdrawal, less any damages
attributable to a wrongful withdrawal.
o No concept of dissociation under
o Limited number of events that trigger dissolution

Business Organizations Book Outline

ULPA 2001 resolves the linkage issue between RUPA and RULPA, but provides (a)
that limited partners have not right to dissociate before termination of the limited
partnership, and (b) that neither general nor limited partners have a right to
distribution upon dissociation. Dissociated partners are deemed to have their own
interests as though they were transferees.

C. Linkage with General Partnership Law

UPA 6(2) provides for the application of the UPA to limited partnerships except in so
far as the statutes relating to such partnerships are inconsistent herewith.
RULPA 101(7) defines a limited partnership as a partnership, 403 provides that a
general partner has rights, powers, restrictions and liabilities of a general partner, and
1105 provides that in any case not provided for in this act, the provisions of the
UPA govern.
RUPA has no provisions applying it to limited partnerships like RULPA.
D. Formation: Formalities and Consequences of Non-Compliance
General partnerships can exist on the basis of objective manifestations.
Forming a limited partnership requires the additional step of filing a certificate with
the state.
LP certificate provides notice both of the firms limited liability statues and of certain
terms of the relationship, including the identity of the general partners to whom
creditors can look for satisfaction of debts.
RULPA 304 and ULPA 2001 306 protect erroneous limited partnersparties who
have contributed capital to a partnership erroneously believing that they have become
limited partners. 304 has also been held to apply where the partnership was formed
and represented as a general partnership until a partner received part of their interest
in a divorce case and tried to claim limited partnership.
Note 3-3
1. Taxation of Limited Partnerships-Flow through partnership taxation is an important reason
for selecting the LP. The new check-the-box tax classification system permits firms to elect
whether to be taxed as a partnership or a corporation.
2. Limited Partnership interest as securities- limited partnerships interests normally are
treated as securities under the federal securities laws.
3.05 Limited Liability Companies
A. The Current State of LLC Law
Positive: a corporation-like limitation on the vicarious liability of managers or
members for the obligations of the LLC, without corporate tax structure.
Statutes: ULLCA, RULLCA, and the Delaware Act
B. An Overview of the LLC Concept
Limited Liability
LLC statutes provide a default rule of limited liability of managers and members.
Members may opt for personal liability, either by giving personal guarantees or be
designation in the articles of organization under the ULLCA, and may be responsible
for making capital contributions or returning distributions.

Business Organizations Book Outline

Vicarious personal liability may also arise by operation of law, as in corporate veil
piercing or responsibility in tort for ones own acts.
Formalities
Creation requires deliberate act with the state.
Operating Agreements
Every LLC has an operating agreement, comparable to the partnership agreement.
LLC statutes, like partnership and limited partnership statutes, provide default rules
where the parties have not expressly dealt with issues in the operating agreement.
Members and Managers
Can either be member manager or manager managed.
One of the most fundamental decisions of an LLC.
In member managed LLC, the analogy between members and partners, in terms of
management and voting rights, is strong.
In manager managed LLCs there are imperfect analogies between manager and
corporate directors or general partners in limited partnerships.
The important issues are the allocation of power among the members and between
firm and third parties.
Conversions and Mergers
LLC laws generally have some provision for allowing partnerships to convert into
LLCs without undergoing dissociation or dissolution. RULLCA and many state LLC
statutes permit conversion form an LLC to another business form.
Financial Rights and Obligations
LLC laws mirror partnership laws in allocating profits, losses, and distributions.
Membership interests are reflected in the operating agreement and are usually not
reflected in share certificates.
Default rules on financial rights vary, however, with some statutes using a partnershipstyle equal allocation, and others basing allocation on the amount of capital
contributed.
Transfers of Interests
LLC statutes parallel partnership statutes in permitting a transfer of only financial and
not managerial rights.
Fiduciary Duties and Remedies

Manager-managed LLCs: fiduciary duties are generally similar to those in

limited partnerships.

Member-managed LLCs are similar to those in general partnerships.

Most LLC statutes provide for derivative actions.

Dissociation and Dissolution
Under the Kitner regulations that predated the check the box rules, LLC had to negate
at least two of the four corporate characteristics in order to avoid the corporate tax.
o One of these characteristics was perpetual life that continued despite dissociation
of the shareholders, LLCs had to be sure that dissociation of a member, like
dissociation of a partner, caused the dissolution of the entity.
The check-the-box rule eliminated the Kitner rulesunder these rules, LLC statutes,
like RULLCA and the Delaware Act dispensed with automatic dissolution upon
dissociation.

Business Organizations Book Outline

Under RULLCA and Delaware Act and many other LLC statutes, dissociation no
longer even triggers buy-out, an approach that is at least partly attributable to estate
tax rules.

Note 3-4
1. Popularity of the LLC form: Dominant business form for closely held firms.
2. RULLCA and other model acts: RULLCA is only adopted in 8 states; Limited Liability
Company Act.
3. State-by-state variations:
C. LLC Formalities
1. Organizing the LLC
All LLCs, similar to limited partnerships and corporations, come into being as a
result of a deliberate act.
EVEN if all the formalities of filing have not been met, members are still
governed by some extent by their agreement. In some cases, members can be
deemed general partners if they havent met the formalities of filing.
Most statutes require minimal information.
All statutes require: name of the company (which has to contain words or an
abbreviations showing it is an LLC)
o RULLCA and Delaware Act follow this minimalist approach.
o ULLCA- permits a member to elect to be liable for debts and liabilities of
the LLC as a matter of the organization of the firm.
Note 3-5
1. Filing:
ULLCA and the Delaware Act are ambiguous on whether the filing with the clerk
without more constitutes filing.
RULLCA 201(d) makes clear that the formation of an LLC occurs only when the
Secretary of State files the certificate of organization. (that is the document is deemed
satisfactory)
2. Organizers
ULLCA and RULLCA refer to the person who gets the ball rolling as the organizer.
Delaware Act only refers to the authorized person who files the certificate of
information.
3. Consequences and Failure to file
Some LLC statutes provide for liability of those who act on behalf of an LLC that has
not been formed.
TG Slater v. Donald Brennan LLC (abbv)imposed joint and several liability for prefiling activities under the Utah Statute, which prohibited transacting business before
filing. Here the Court applied the corporate promoter laws since LLCs receive certain
corporate functions with limited liability.
In another case, the Court applied the de facto law to hold that an LLC could sue
although it had not met the statutory requirement for formation, finding no compelling
reason why de facto analysis borrowed from corporate law, ought not to apply.
4. Federal Diversity of Citizenship Jurisdiction

Business Organizations Book Outline

Citizenship of a corporation for federal diversity jurisdiction purposes is determined

by the corporations state of incorporation and its principal place of business.
the general rule is that all unincorporated entities have the citizenship of each partner
or member for purposes of determining whether diversity jur exists.
Therefore, it is more difficult to establish complete diversity among parties when
dealing with partnersihps.
LLC is characterized as a partnership for diversity jur purposes.

2. Member Requirements
RULLCA 201(b)(3) and (e) provide that an LLC without members has not been
formed, but allows for shelf registration as long as the certificate of formation states
that it is for a no-member LLC.
o Shelf Certificate of formation lapses unless an organizer files another
certificate within 90 days thereafter declaring that the LLC has at least 1
member. LLC is deemed to have been formed at the date the member was
admitted.
o The shelf LLC does not exist for any relevant purpose, including liability
protection.
Delaware Act: LLC is formed at the time of the filing of the certificate if there has
been substantial compliance with 201 of the act which requires that an LLC have an
operating agreement.

Note 3-6
1. Amending the statutes: state legislatures may eventually ament the no-member statutes.
2. The one-member LLC: LLCs can have one member; DIFFERNCE FROM
PARTNERSHIPS, since partnerships require two+ members.
3. The Operating Agreement
a. role of the operating agreement
The heart of any LLC is (or should be) the operating agreement.
Addresses the same matters that should be addressed in the partnership agreement:
management and financial rights, continuation of the firm after dissociation, transfer
rights, and so on.
b. Writing requirements
Most LLC statutes (ULLCA and RULLCA) do not require that the operating
agreement be in writing. Can include a non-written mutual understanding, no matter
how informal, but possibly subject to the applicable Statute of Frauds if it called upon
tasks that last more than 1 year to complete.
General Statute of Frauds applicable to contracts may require a written agreement
even if the statute does not.
Note 3-7

Business Organizations Book Outline

Since RULLCA and the Delaware Act define an operating agreement to include an
implied agreement, as well as an oral or written agreement, regarding the affairs of the
LLC, and the LLC statute fills the gaps in operating agreements, an LLC can exist
without an express operating agreement.
c. Interpretation of the Operating Agreement
Relatively little case law interpreting LLC statutes or agreements.
Courts apply cases concerning other types of business associations.

Note 3-8
1. Writing Requirement
2. Who is bound
LLC agreements are typically defined as agreements among the members; Operating
agreement among the members does not automatically bind third parties;
Non-members, including non-member managers, can be made parties to or third party
beneficiaries of the agreement under general contract law.
RULLCANON MEMBER MANAGERS- automatically bound by the operating
agreement, but general non-members are not bound.
3. The articles and the operating agreement.
Parties can put provisions that should be in the operating agreement in the field
articles. All field articles are considered part of the operating agreement.
RULLCA 112(d)in an event of conflict between a provision of the articles of
organization and the operating agreement, the operating agreement prevails among the
members, and the articles prevail among third parties, to the extent that third parties
have relied on the articles.
4. what is and what is not an operating agreement?
Operating agreements are contracts governed by contract law. Under LLC statutes,
only an operating agreement can vary the statutory default rules. It is important to
determine what constitutes an operating agreement, but it is not clear why some
agreements dont have the effect of an OA:
o RULLCA 102(13): defines an OA as one among all the members.
o RULLCA 111(c): provides that members may make a pre-formation
agreement that wlll become an OA upon formation if the agreement so
provides. If the formation agreement doesnt include the magic words, it does
not qualify as an operating agreement.
5. Is the LLC a party?
If the LLC is a party to the operating agreement, the LLC arguably must be joined in
an action to enforce the agreement. The presence of the LLC may destroy complete
diversity.
If the LLC is not a party, it could prevent arbitration of a dispute among the members
pursuant to an arbitration clause in the OA.
RULLCA 111(a)provided that an LLC is bound by and may enforce the operating
agreement, regardless of whether the company manifested assent and is included as a
party in the OA.

4. Conversions from Partnership

General partnerships gain the liability shield when they convert to an LLC.

Business Organizations Book Outline

Limited Partnerships eliminate the danger of the limited partners loss of the liability
shield by participating in the control of the enterprise.
Most statutes enable GP and LP to convert to LLC form.
ULLCA- permits conversion from GP and LP (only addresses these entities)
RULLCA- permits conversion from any business form other than a domestic or
foreign LLC, as long as the governing statute of the converting entity permits the
conversion.
Delaware LLC Act: permits any other entity, including corporation, unincorporated
entity, or foreign LLC to convert if conversion has been approved in the manner
provided for by the documents that govern the converting entity.

Note 3-9
1. Effect of Conversion
Entities cannot convert into an LLC then file for bankruptcy to avoid liability.
ULLCA and RULLCAconverted entity is the same entity for all purposes;
Delaware act converted entity is the same entity for all purposes under the laws of
the state of Delaware
2. Sole Proprietors formation of an LLC
Can sole proprietors convert to LLCsCourt typically looks to fairness of conversion.
3. Impact of Conversion on Converted entity
Delaware Actconverting entity shall not be required to wind up its affairs or pay its
liabilities and distribute assets, and the conversion shall not be deemed to constitute a
dissolution of such other entity.
ULLCAPartnerships or Limited partnershipsprovides that the filing of the
certificate of conversion has the effect of cancelling the certificate of the limited
partnership.
4. Conversion from LLC to another form:
RULLCA permits an LLC to convert out of LLC status (not contemplated by ULLCA
or Delaware).
5. Series LLCs
Several LLC statutes permit a firm to designate series of members, managers, or LLC
interests with separate rights, powers or duties with respect to specified property or
obligations or profits and losses associated with this property or obligations as well as
separate business purposes for investment objectives.
MOST importantly: liabilities may be charged to the property allocated only to one
series and not to other series.
RULLCA and ULLCA: do not provide for series.

6. Non-Profit LLCs
Firms can look exactly like businesses, but still organize for non-profit.
There are special statues for non-profit corporations that protect contributors, but no
such statutes for non-profit LLCs.

Business Organizations Book Outline

Non-profit LLC helps fill the gap in state laws for non-profit corporations. A nonprofit
under state LLC and corporate statutes involves rules separate from those applying to
tax-exempt organizations under the Internal Revenue Code.
7. Choice of Law
In choosing the state of incorporation, an LLC implacability chooses the state law that
will provide the default rules for management, financial, fiduciary duty and other
internal governance matters.
Choice of law state is an important initial planning consideration for two reasons:
o (1) unlike partnerships and limited partnerships, there is substantial differences
among the states in their LLC statutes.
o (2) unlike general partnerships, LLC statutes have adopted something like
corporate internal affairs rule, which applies the law of the state of
organization wherever the LLC does business.
Only a firm that is a foreign limited liability company may do business in a state
subject to its formation-state law.
Most LLC statutes provide that the law of organization jurisdiction governs the
internal affairs, organization or liability of members of foreign LLCs.
The main question of choice-of-law is third parties.
o First, many statutes do not make clear which states law controls members
power to bind the LLC in third-party transactions.
o Second, question concerns the extent to which the LLC is subject to regulatory
law in the operation state that differs form comparable law in the formation
state.
o Third, which state laws veil piercing law applies?
8. Special Issues in LLC Law
a. Securities law
Presumption against apply security laws to partnerships because GPs generally
participate actively in the business and therefore do not need the same sort of
protection afforded to securities investors.
Centrally managed LLCs are more likely than member-managed firms to be
characterized as securities.
b. Other Regulatory Laws
Problems with characterizing an LLC under regulatory statutes because at the time
they were invented, they were not named in the statutes. Courts interpret what the
statute was intended to do coupled with what LLCs were invented to do.

Note 3-11
1. LLCs under criminal statutes
Same apply regulatory laws, Courts like to leave the decision of whether to apply
criminal statues (such as embezzlement) up to the legislatures.
Court imposed criminal liability on a long-term care facility, noting that it was not a
corporation, rather it was a person.
2. Statutory Drafting
3. Diversity Jurisdiction
There is federal diversity jurisdiction if the amount in controversy exceeds $50,000.00
and no plaintiff has the same state of citizenship of any defendant.

Business Organizations Book Outline

Courts are to apply the traditional rule pertaining to unincorporated entities which
insists on looking through the business association to the citizenship of the members.
4. Characterization under contracts:
Nature of LLC may matter under private contracts as well as regulatory statutes.
The Enron suit turned on the fact that an LLC is so similar to a corporation in that
they both limited liability that the LLC was included under the term corporation.
5. Attorney-Client Privilege
Typically, the LLC is an entity and the members are advised to get separate counsel
for litigation involving the LLC. The LLCs attorney does not represent the members
and the LLC collectively.

c. Professional Firms as LLCs

Most important LLC use: law and accounting firms.

Note 3-12
1. LLC statutes:
Most states specifically authorize use of the LLCs by professional firms, usually
under separate provisions that apply to professional firms. Typically have the same
issues as professional partnerships.
2. Licensing statutes and court rules:
Firms must check with the local Supreme Court for licensing issues.
3. Legal restrictions on the scope of limited liability:
Professionals are subject to the professional corporate restrictions on liability limits.
4. Ethical restrictions and the scope of limited liability
MCPR: MRPC: lawyers cannot limit their liability for their own malpractice.
Restatement Third of the Law Governing Lawyers: Principle of a law firm organized
other than as a general partnership without limited liability as authorized by law is
vicariously liable for the acts of another principal or employee of that firm to the
extent provided by law.
Law firms that become LLCs may have to give detailed notice.
7. Multistate Professional firms:
General rules for LLCs choice of law may not apply to professional firms. A multistate firm operating in a state that restricts the use of the LLC form by professionals
may have to use different letterheads, names, etc. Still yet, they may be misleading
customers and violating law in their home states because of what they do in their
states of corporation.
8. Policy Issues
Since professionals have wealth and firms have little assets, the unlimited liability
arguably helps ensure that professionals will monitor their co-partners work.

Business Organizations Book Outline

However, this imposes heavy burdens. Unlimited liability may restrict the size of
firms thereby reducing their ability to provide adequate checks on members. The
question of whether firms should be able to choose to be vicariously liable or instead
become an LLC or an LLP is debated especially after the Enron debate.
3.06 Other Forms
Firms choice of business association depends on: whether it wants corporate tax or
single- level partnership taxation; default rules regarding such issues as management
form, durability of the entity and fiduciary duties; and the application of regulatory
statutes, such as the federal securities and employment discrimination laws.

Business Organizations Book Outline

Part II: The Life of the Enterprise

Chapter 4: Agency, Management, and Control
4.01 Introduction

Fundamental questions of agency

a. Formation and existence of agency relationship;
b. How an agent comes to be authorized to act on behalf of the principal;
c. How a principal may maintain legal control over the actions of an agent;
d. How the issues of agency, management, and control appeal in unincorporated
forms.
Agents are given power to act in the interest of the firm, but he/she may be tempted to
act in their own interest.
Agent is entitled to act either by direct manifestation or by default rules.
Problem arises when agents commit a tort or breach of contract, the third party has no
practical recourse against the agent, and either the principal or third party is going to
get stuck.
Loss is typically placed on the cheaper cost avoider.

4.02 Existence of Agency

Threshold question is whether the parties are in agency relationships.

Agency can be an informal relationship existing without a written agreement.

A. Definition
Agency is a fiduciary relationship that arises when the principal manifests assent to
the agent that the agent shall act on the principals behalf and subject to the
principals control, and the agent manifests assent or otherwise consents to act.

Thus: (1) consent by both principal and agent; (2) control by the principal; and (3)
action on behalf of the principal typically constitute an agency relationship.

1. Consent
Gratuitous agents arent uncommon.
The agency contract may be express or implied;
Does not require explicit consent to be agent and principal, rather their consent to
enter into a relationship behalf of the entity and containing the control elements of
agency.
2. Control
The control aspect is important because it supports attributing the consequences of an
agents act to the principal.
3. Action on Behalf of the Principal
Agents fiduciary duty of loyalty: Agents agree to disregard their own interest and act
for the principals benefit. This supports holding a principal liable for his/her actions.
Agency can exist even when the agent doesnt produce a benefit for the principal.

Business Organizations Book Outline

B. Agents, Intermediaries, Independent Contractors and the Firm
Agency relationship must contain ALL the elements of agency.
For example, a trust is not an agency because the trustee is not subject to the
beneficiarys control.
Restatement Third of Agency: many common legal relationships do not by
themselves create relationships of agency. These include relationships between
supplies and resellers of goods or property, franchisors and franchisees, lenders and
borrowers, and parent corporations and their subsidiaries.
The line between agency and non-agency relationship is not always clear: See Cargill.
Gay Jenson Farms Co. v. Cargill, Inc. 309 N.W.2d 285 (Minn. 1981)
Plaintiffs 86 individual, partnership, or corporate farmers, sued Cargill and Warren
Grain when defendants defaulted on contracts to sell grain to the plaintiffs.
Case arose from the financial collapse of Warren Seed and Grain Co. and its failure to
satisfy its indebtness to plaintiffs. Contract between W and C to finance W. C took
various steps to control W and continued to increase Ws credit line as lone as W
acted pursuant to Cs recommendations; After an audit revealing Warren was in
$4million dollars of debt, it ceased operations. At this time, Warren owed Cargill 3.6
million and plaintiffs 2 million.
Plaintiffs are suing Cargill alleging that Cargill is jointly liable for Warrens debts.
Issue: Did Cargill become liable as principal on contracts made by Warren with
plaintiffs?
o Agency relationship existed: by directing Warren to implement its
recommendations, Cargill manifested consent that Warren would be its agent.
Warren acted on Cargills behalf in procuring grain for Cargill as the part of its
normal operations which were totally financed by Cargill. Further, Cargill
interfered with the internal affaires of Warren by taking de facto control of the
elevators.
Factors showing Cargills control over warren:
1. Cs recommendations to W via phone;
2. Cs right of first refusal;
3. Ws inability to enter into mortgages, purchase stock, or pay dividends without
Cs approval;
4. Cs right of entry into Ws premises and ability to conduct periodic checks and
audits;
5. Cs correspondence and criticism m regarding Ws finances, officers salaries and
inventory;
6. Cs determination the W needed strong parental guidance;
7. Provision of drafts and forms to W upon which Cs name was imprinted;
8. Financing of all Ws purchases of grain and operating expenses;
9. Cs power to discontinue the financing of Ws operations;
Cs primary purpose for financing W was not to make money as lender, but to
establish a source of market grain for its business.
Holding: This relationship is not a normal debtor-creditor relationship. Sufficient
evidence from which the jury could determine that C acted as principal of W within

Business Organizations Book Outline

the definitions of agency set forth in the Restatement. (Consent by the principle, agent
acting on behalf of the principle, under the principles control existed here)
Note 4-1
1. Control
Having veto power doesnt always indicate control. The party who is making the basic
decisions about running the business is normally the one who is in the best position to
make cost-benefit decision. A party having veto power is only a narrow window to engage
in the balancing process.
2. Benefit
Cargills did not receive Warrens profitsthus it is missing an agency ingredient.
However, the other factors in Cargill showed that it entered into the relationship for the
benefit of receiving grain.
3. Negligent Exercise of Control
Non-principals may be liable for negligence in exercising control over another.
Connor v. Great Westernbank held liable for financing contractor who build faulty
houses.
4. Agent by estoppel
One may be liable for misleading another into thinking that a transaction was entered into
on his behalf.
5. Marital Agency
Historically, women had no right to hold property, etc. Wife could only act as an agent for
her husband. Courts created complex bodies of law to protect marital assets from
creditors, under the guise of protecting women from the indebtedness created by their
husbands.

4.03 Duties Between Principals and Agents

A. Duties of Agent to Principal
1. duty of loyalty(fundamental duty) to act solely for the benefit of the principal.
a. Includes the duties to account for profits arising out of the agency, not to act
adversely to the principal without the latters consent, and not to compete with the
principal on maters relating to the agency.
2. Duty of care, competence and diligenceagent should act how an agent in similar
circumstances would, unless the agent has special skills or knowledge.
3. Duty not to acquire material benefits arising out of the agency- A may not acquire a
material benefit from a third party in connection with transaction or actions taken on
behalf of the principal or otherwise through As position.
4. Duty not to act as (or on behalf of) and adverse party- an agent may not deal with the
principal as or on behalf of an adverse party in a transaction.
5. Duty not to compete- agent may not compete with the P or take action on behalf of or
otherwise assist the Ps competitors. (Does not prohibit the A from preparing to compete
following the end of the agency relationship, as long as the conduct is not wrongful).
6. Duty not to use the principals property
7. Duty of good conduct
8. Duty to provide information

Business Organizations Book Outline

General Default Fiduciary Duties provided for by common law rules and statutes may
be varied by contrary agreement.

B. Duties of Principal to Agent

1. Duty to indemnify- the principle must typically indemnify an agent for costs, expenses,
and/or damages incurred by the agent in the scope of the agency relationship or when
acting for the principals benefit, and/or in accordance with any agreement between the
agent and the principal.
2. Duty of good faith and fair dealing- a P must inform its agents about risks of physical
harm or financial loss that the P knows, has reason to know, or should know are present in
the agents work, but are unknown to the agent.

Apart from liability to employees that arise under worker compensation, employee safety
and other laws, the duties of principal to agent are primarily a matter of contract.

4.04 Termination of Agency

Agency is inherently a consensual relationship and so continues only as long as consent

lasts.
Agency relationship terminates when: (1) the parties agree; (2) when either manifests to
the other dissent to its continuation; or (3) on the death or loss of capacity of either party.
Termination of actual authority doesnt terminate apparent authority.
Principal may have the power to terminate the agency, but not the right to do so. If the
termination is in violation of a contract, statutory employee-at-will provision, damages
must be dealt with.

4.05 Management and Transactional Authority

A. Agency Principles
Agents may have management responsibilities.
Agents internal and external power may differ. The internal power depends solely on the
contract with the principal, but the external power may be enlarged to meet a third partys
expectations.
An agent who acts beyond her internal authority and binds the firm may be liable to the
principal.
Agents power to bind the firm is based on his/her authority.
Principal creates actual authority by manifesting to the agent the principals consent to be
bound by the agents acts.
Real authority can be expressed or implied from circumstances or courses of dealings
between the principal and the agent.
Ex:
o Mary asks Carl to negotiate a contract with tom to build a new device. Carl and
Tom sign a contract. Mary is bound because she gave express authority to Carl to
act on her behalf.
o However, suppose Tom was in Dallas, so Carl flew to Dallas and Mary later
decided that she shouldnt have to pay for the plane ticketshe cant back out

Business Organizations Book Outline

because Carl had implied authority because his actions were within the purview of
marys instructions.
Apparent authority exists when the principals acts create an appearance of authority
from the perspective of third parties dealing with the agent whether or not the principal
has consented to be bound by the agents acts.
Authority principles discussed in case law do not apply to circumstances in which tort
victims (those with involuntary relationships with the agent) seek to hold the principal
liable for injuries suffered. Typically, the principal is only liable when the agent is acting
in the normal course of dealings or some other action related to the relationship.
1. Apparent and Actual Authority
Essco Geometric v. Harvard Industries
This case involved a purchasing manager who was replaced. He used to bind the principal
with contracts, especially with Diversified foam (the plaintiff). New management came in,
and a primary concern was the reliance on Diversified. Ceresia, a lower level purchasing
agent, allowed three companies to bid on a job. A bid from another company was
accepted. Another job came up, and Ceresia did not allow Diversified to bid. Gray, the
new purchasing manager, was contacted by Diversified, Gray then orally agreed with
Diversified to give all of its foam business. Kruske, the boss, was not aware of this
agreement until May of 1990. Diversified wrote a letter to Gray in January that
represented the terms of the agreement. Gray found out later that Ceresia was misdirecting
purchase orders to American instead of Diversified, and he talked to Kruske about it. Then
Kruske decided to make American their principal supplier.
There was no job description that outlined Grays responsibilities. Diversified argued that
Gray had actual authority to bind the firm as he did. The court found that there was
evidentiary support for this claim.
o First, Greys testimony showed that he believed that he had the power to bind the
firm.
o Second, there was an evaluation of Grey that expressly stated he should take on a
more active role in managing his department.
o Third, the customs of the industry and the former purchasing manager gave
support to this argument that Grey should be able to bind the firm in this manner.
Harvard countered with a memo that required every purchasing order or requisition over
50 dollars go thru Kruske, but they never actually followed this policy.
Apparent authority: Apparent authority is created by the conduct of the principal which
causes a third person to reasonably believe that the purported agent has the authority to act
for the principal, and reasonably and in good faith rely on the authority held out by the
principal.
Holding: The court found that through a combination of position and prior acts, the court
could have found that Gray had apparent authority to bind the principal.
Burden is on the principal to limit implied authority.
Note 4-2
1. Identifying the Parties
2. Corporate bylaws

Business Organizations Book Outline

Corporations generally use a mixture of express actual authority, implied actual authority,
and apparent authority to empower their agents.
3. Manifestations
Principals manifestations of authority to third parties are important.
Restatement of (Second) Agency 8 turns on whether the principal has done something to
make the third party reasonably think the agent had authority.
Problem with Restatement 2: Apparent authority actually seems to arise even when the
principal does very little to convey an impression to a third party.
Restatement Third of Agencymerely requires the third party to have reasonable belief
that is traceable to something the principal did.
4. Policy basis of apparent authority
Law of agency can be viewed as a way to minimize the costs of apparent authority by
providing the rules that most parties would contract fora kind of hypothetical bargain.
Hypothetical Bargainimposes the risk of loss on the party that could most cheaply
have prevented the agent from departing from the principals willthe least cost
avoider concept.
o EX: if the transaction looks to the third party like on the principal could not have
agreed to, as where it benefits only the agent, the third party is the least cost
avoider and the transaction should not be enforceable against the principal.
o Principal is often least cost avoider because there is so much principals can do to
control agents errors through better monitoring, instructions, and selection of the
agent. In these cases, law should bind the principal even when the agent departed
from the instructions.
5. Implied vs. Apparent Authority
Apparent authority is not about what the principal wants the agent to do. It is about waht
the third party reasonably believes the principle has authorized the agent to do.
o Do not look at communications between principal and agent. Look at
manifestations between principal and third party.
Implied authority- involves examining the principals instructions and asking what else
might be reasonably included n those instructions to accomplish the job. Includes actions
that are necessary to accomplish the original instructions and also those actions that the
agent reasonably believes the principal wishes him to-do based on the agents reasonably
understanding of the authority granted to him by the principal.
6. Estoppel
Estoppel permits third parties to recover from principals as a result of unauthorized agent
transactions or acts. Estoppel involves principals carelessly letting a third party rely to its
detriment on the agents assertion of authority.
Estoppel doesnt depend on the principal creating an appearance of authority.
Third party must change their position in reliance upon the authority of the agent.
7. Restitution
Involves recovery for a benefit a third party has conferred on the principal for which the
principal should be required to pay.
8. Ratification

Business Organizations Book Outline

Occurs by the principals affirmance of an earlier unauthorized act.

This includes any conduct manifesting consent to be bound by the transaction, this
includes failing to say anything about it under circumstances in which silence may be
interpreted as consent, even though the third party did not rely on the consent and did not
confer a benefit on the principal.
The principal can avoid the effect of the affirmance if the purported principal is ignorant
of material facts involved in the original transaction, and is unaware of his ignorance.
Restament Second 82 comment d: the best defense of ratification is pragmatic; that it
is needed in the prosecution of business. It operates normally to cure minor defects in an
agents authority, minimizing technical defenses and preventing unnecessary lawsuits.

2. Inherent Authority

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 actual authority, apparent
authority or estoppel, but solely from agency relationship, and exists for the protection of
persons harmed by or dealing with a servant or other agent.
o Comment to this section: It is inevitable that in doing their work, either through
negligence or excess of zeal, agents will harm third persons or will deal with them
in unauthorized ways. It would be unfair for an enterprise to have the benefit of the
work of its agents without making it responsible to some extent for their excesses
and failures to act carefully. The answer of the common law has been the creation
of special agency powers or, to phrase it otherwise, the imposition of liability upon
the principal because of unauthorized or negligent acts of his servants and other
agents.
Inherent agency power is rarely used. It is used more in cases where the principal has
given a managerial agent broad power to run the business and communicated no limit on
authority to third parties.
Restatement 3d Agency: eliminates the concept of inherent authority.
Problem with inherent authority is that courts seem to be imposing liability even when the
principal authority has done nothing to take responsibility for the agents acts.

Kidd v. Thomas A. Edison, Inc., 293 F.405 (S.D.N.Y.) (2d Cir. 1917)
FACTS: Maxwell directed Fuller to engage the singer plaintiff in tone recitals so they
could persuade dealers to book her. Therefore, the dealers would pay for the plaintiff and
the defendant would guarantee the signers performance. Plaintiff says that she thought
they were booking her for a full singing tour; however, this is not what Maxwell had told
fuller to do. Maxwell directed fuller to conduct the tone tests and nothing further, thus
he did not have the authority to do otherwise.
The defendant tries to argue that the tone recitals are a new custom separate from anything
the industry has every done; however, the Court notes that from the singers point of view
(the third party), Fuller would have the authority to convey such information.
Look at the cheapest cost avoider: here, Edison is the cheapest cost avoider because it
was the only one in position to ensure the parties were aware of the new custom, and
wouldnt be the same type deal as the past.

Business Organizations Book Outline

There was no actual authority here. Edison did not expressly ok this, rather, Edison
expressly limited Fuller and Maxwells ability to pay singers. No apparent authority
either.
Court finds inherent authority existed based on industry custom. Court creates a legal
fiction to protect third parties. This comes down to the cheapest cost avoider.
This case can be looked at as apparent authority as well. Edison was the guarantor of the
contract, so the agent should be able to bind the principal.

Note 4-3
Master/Servant laws influence agency law. ON THE EXAM, make sure you go
through actual (express/implied), apparent, and inherent authority.
3. Undisclosed Principals
Concept is of inherent authority is not completely dead. Inherent agency power lives in a
broad group of cases involving undisclosed principals. Restatement says, apparent
authority is not present when a third party believes that an interaction is with an actor who
is a principal.
Watteau v. Fenwick, 1 Q.B. 346 (1892)
Facts: Humble owned a pub. Brewery buys out the pub from Humble, but still keeps him
in charge, and it holds itself out as he is the guy running it. They do not allow him to
purchase anything other than the beer for the pub. There was no communication between
the third party and Principal Brewery. Humble bought things he did not have authority to
do, and he leaves, but still owes Watteau for the Bovril.
Holding: Court found liability in the principal via inherent agency power. This
protects third parties. This should also probably be an estoppel case. There cannot be any
apparent authority if the third party does not know the principal exists. Estoppel requires
reliance and here the 3rd relied on A and not the principal. This would only really bind the
principal if it could be shown that the principal was deriving a benefit from the pub being
regarded as a public house still.
Morris Oil, Inc. v. Rainbow Oilfield Trucking, Inc., 106 N.M. 237, 741 P.2d 840 (1987)
Dawn: engaged in oilfield trucking (Farmington); Rainbow: oil field trucking in another
area (Hobbes area); Rainbow entered into several contracts where Rainbow would use
dawn for trucking purposes. Dawn reserved full right and control of the operations in its
area; Dawn was to collect money due from transportation conducted by Rainbow, and
after deducting fees, remit the balance to rainbow.
Under a sub-contract, Rainbow was to be responsible for payment of operating expenses,
including fuel. The subcontract also provided that all operations utilizing fuel were to be
under the direct control and supervision of Dawn. All billing services by Rainbow were
made under Dawns name and Dawn collected all the money.
In another agreement, Rainbow gave Dawn control of Rainbow Hobbes operation.
Agreement said Rainbow was not to become an agent of Dawn and was not
empowered to incur or create any debt or liability of Dawn other than in the
ordinary course of business relative to terminal management. Also said that Rainbow
was to be an independent contractor and not an employee.

Business Organizations Book Outline

Under the above contracts, Rainbow developed a relationship with Morris whereby Morris
installed a bulk dispenser at the Rainbow terminal and periodically delivered diesel fuel
for use in the trucking operation.
Enterprise proved unprofitable and Rainbow went out of business, owing morris 25k.
When Morris went to collect, it was directed towards Dawn since all the operations in
relation to Rainbow had left.
When Rainbow ceased, Dawn took certain important steps: started an escrow account
to settle claims arising from Rainbow. Dawn told Morris about the escrow ccount and said
payment would be forthcoming. No explanation at trial why Morriss claims were not paid
and others were from the account.
Dawn argued that the agreements between Rainbow and Dawn shielded Dawn from
being liable. The Court held this reasoning to be faulty for two reasons:
o (1) the agreement stated that rainbow could create liabilities in the ordinary
course of business;
o (2) third parties cant be bound by documents they arent aware of; when parties
appear to be one thing to third parties, the court will find them liable.
HOLDING: Court found that the undisclosed principal is subject to liability to third
parties with whom the agent contracts where such transactions are usual in the
business conducted by the agent, even if the contract is contrary to the express
directions of the principal. Secret instructions or limitations placed upon the authority of
an agent must be known to the party dealing with the agent, or the principal is bound as if
the limitation has not been made.
o The court also noted that a principal may be liable for the unauthorized acts of his
agent if he principle ratifies the transaction after acquiring knowledge of the
situation. Here, Dawn ratified the account when Morris contacted Dawn and Dawn
did not dispute the legitimacy of the account.
Court further held that this was ordinary business debt or expenses made so that the
principal was liable for the expenses. The undisclosed principle is liable because the P
induces the A to do his bidding. It doesnt matter if the third party knows who the P is. P is
still getting a benefit and having the AC act on their behalf with the Ps backing.

Recognize:
Actual authority vs. 3rd party perception
Value in undisclosed principal liability
Agents liability w/ undisclosed principal
o The agent becomes liable because theyre the one dealing. As an agent, make clear
when youre entering into things on behalf of an entity, make sure its known
youre acting on anothers behalf.
Election of agent/principal in such cases.
Note 4-4
1. Policy basis for liability
Liability can usually be justified because the P is the least cost avoider.
The 3rd party may misjudge the credit risk because she mistakenly believes that the
agent actually owns substantial business assets. It is not clear if further investigation is
necessary, although often triggers that the third party should have investigated further.

Business Organizations Book Outline

2. The Restatement and Inherent Agency Power
The Third Restatement kills inherent agency power, only to resurrect it for purposes of
dealing with the tricky problem of undisclosed principal liability.
Section 2.06an undisclosed principal is subject to liability of a third party who is
justifiably induced to make a detrimental change in position by an agent acting on the
principals behalf and without actual authority if the principal, having notice of the
agents conduct and that it might induce others to change their positions, did not take
reasonable steps to notify them of the facts. Further, an undisclosed principal cant
reduce or qualify the agents authority to less than the authority that a third party would
reasonably believe the agent to have under the same circumstances if the principal had
been disclosed.
3. A counterargument
Undisclosed principal liability thwarts the actual deal the parties have made for the third
party to rely solely on the agents credit. This indicates that it is worth it to the principals
like Dawn to have third parties like Morris bear the cost of Rainbows credit risk. Thus,
the third party, not the principal is sometimes the least cost avoider.--- NOT RAISED IN
CLASS, but could be a defense that Dawn was actually the third party dealing with Morris
not likely.
4. Who is liable?
The agent and the undisclosed principal are liable, so long as its consistent with the third
parties expectations.
Note Morris discusses that the plaintiff must elect remedies and cannot proceed to
judgment against both the agent and principal. A principal who is held liable can sue the
agent for acting beyond his authority. If the third party is willing to pursue the agent, this
suggests the agent was solvent and would ultimately bear liability. If a principal does not
pursue the agent, he waives his right.
5. Unidentified principals
If the third party has notice that the agent is or may be acting for the principal, but not of
the principals identity, the principal is unidentified. Under Restatement Third 602,
both the principal and the agent are parties to the contract, in the latter case unless the
agent and the third party agree otherwise.
B. Partnership and Limited Partnership

1. Management Rights Among General Partners

Business partners make substantial investments, thus it follows that they want some say in
making their investments are spent wisely. At the same time, the members do not want to
become so involved in management and watching their partners that this takes away from
more valuable ways to spend their time.
Two categories of partner management rights and powers:
o (1) those that apply among the partners themselves; and
o (2) those that apply vis-a-vis third parties.
Partners Management Rights Among the Statutes:

1. The right to manage

Business Organizations Book Outline

UPA 18(3) and RUPA 401(f) give all partners the right to participate in the governance
of the firm. Also, a partners contribution is not limited to financial investments, services
and credit are also included with partners.
DIFFERS from a corp where board manages and shareholders vote.

2. Equal voting rights

Partners have equal rights to participate in managementeach partner gets one vote.
DIFFERS from a corporation where votes are proportionate to shares.
3. Vote required to take action: statutory rules
UPA and RUPA: in an event of a disagreement, majority vote controls.
However, a single member does have the right to veto major partnership decisions.
o Single members can veto the admission of new partners.
UPA 18(h): majority controls as to ordinary matters, acts in contravention of any
agreement between the partners must be decided unanimously. Thus for extraordinary
acts, unanimity is required.
4. Applying the statutory rules
The parties express and implied agreement should outline what individual partners can
veto.
In absence of a specific agreement, the Court may assume that the parties would have
adopted an economically reasonable agreement that balances the expected decisionmaking costs of a high-vote rule against the expected costs to dissenting partners of being
outvoted.
Ex. of extraordinary: (1) changing the form of the business; (2) when two partners wanted
to race a horse despite his injury and the third partner objectedthe Court held that this
was extraordinary because the race could damage the partnerships only asset.
5. Fiduciary duties and management rights
Partners management rights are closely related to their fiduciary duties and remedies
discussed below. Information is required to vote and participate in management, thus
partners have a fiduciary right to disclosure.
2. Partners Authority to Bind the Partnership

Like non-partner agents, partners may have more extensive power to bind the partnership
in transactions with third parties than they do among their co-partners.
EX: Case held that even if a 99year lease was in the ordinary course of the partnerships
business for purposes of partners authority to bind the partnership in transaction with
third party, this does not affect co-partners management rights for purposes of dispute
among partners.
Under UPA 9 and RUPA 301the general principal is that each partner is an agent. Each
partner has the power to bind the firm when the partner is apparently carrying on in the
usual way of the partnership business. This is the scope of the partners apparent
authoritythird parties must be notified of any limitation on partners authority.

Business Organizations Book Outline

UPA 9(2) and RUPA 301(2)a partner can bind the partnership even in transactions that
are not usual or ordinary if they are actually authorized by the partnership.
o Partners who bind the firm without actual authority may be subject to sanctions
within the firm including liability to the other partners and inability to obtain
indemnification from the other partners for payments to they must make to the
third parties.
UPA 9(3)(c): Partners acting without the approval of the remaining partners may not do
any act which would make it impossible to carry on the ordinary business of the
partnership.
UPA 10(3): Where title to real property is in the name of one or more partners, the
partners in whose name the title stand may convey title to such property.

Patel v. Patel, 212 Cal.App.3d 6 (1989)

One partnership agreed to sell their only asset, a hotel, to another partnership. They did
not get the consent of the third partner, their son, and the buying partnership did not have
any notice that the son was a partner. They even searched the public records and were
unable to find any information that he was a part of the partnership.
The Court found that UPA 9 prevails over UPA 10. Held plaintiffs were entitled to
damages, but not specific performance.
Note 4-5
1. The scope of partner authority:
In the Patel case, the son had a right to veto the sale and his parents wrongful sale
violated UPA 18. This is a conflict between UPA 9(j) and 18.
UPA 9(1): any act of partner apparently carrying on the business of the business of
the partnership is permitted.
UPA 18 makes it clear that non-ordinary transactions may only be authorized by a
unanimous vote of the partners.
The sale of an only asset does not fall within the ordinary course of business.
2. Presumptively unauthorized transactions
UPA 9 contains categories of presumptively unauthorized transactions, one of which is
applied in Patel.
a. 18: acts of partners which are not apparently for carrying on the business in the
usual way do not bind the partnership without approval of all partners.
b. certain specific acts, such as confession of judgments or the disposal of goodwill,
may only be authorized unanimously.(not included in RUPA)
c. any act which would make it impossible to carry on the ordinary business of the
partnership is presumptively unauthorized without unanimous consent of the
partners.
2. It is clear from the note in Patel that the Court is more concerned with the
continuation of the partnership.
3. Real Property Transfers

Business Organizations Book Outline

Title of real property passes if it is authorized by all parties, unless the transaction is
unauthorized under UPA 9(1) and the purchaser is not a holder for value without
knowledge.
Even if the transaction was extraordinary, perhaps it should have bound the partnership if
the third party reasonably believed based on record title that all owners had joined in the
transfer.

4. RUPA
Applies to property other than real property;
In another case similar to Patel, the Court held that neither the purchaser nor a subsequent
transferee had constructive or inquiry notice of the transferring partners lack of authority
based on the partnership agreement since the agreement could not be considered in the
chain of title.
5. Notice to the partnership
The partners power to bind the firm goes beyond entering into contracts on behalf of the
partnership.
UPA 12 and RUPA 102notice to or knowledge of a partner may constitute notice to or
knowledge of the partnership.
Notice to or knowledge of a partner is ineffective as to the partnership if the partner is not
defrauding the partnership.
6. Partner Admissions
A partners statement may bind the partnership as an admission.
UPA 11an admission is probably an act covered by RUPA 301.
3. Management and Control Agreements in Partnership

a. Allocating Management and Voting Rights

Partners may agree to concentrate management power in one or more managing partners.
Variations from the statutory default rules may be strictly interpreted.
Courts may assume that partners who are vicariously liable for the firms debts, wanted
some decision-making role and some reins on managers even if the agreement literally
seems to provide other wise.
The court can also find that excluding others from management unless the agreement
explicitly provided for such exclusion.
The balancing act underlies the provisions of the partnership agreement that determine the
matters on which the managers may act without partner approval.
Partnership agreements usually state that the manager has the power to act without partner
vote except as to certain designated matters.
A general distinction between day-to-day (managers are permitted to handle) and
extraordinary matters creates much uncertainty and potential for litigation.
The agreement might make narrow exceptions, such as for asset sales or admission of new
partners.
Provisions directly limiting the mangers freedom to act are not the only way to control
the managers exercise of discretion.

Business Organizations Book Outline

o Managers incentive to act consistently with partner interests is affected by, among
other things;
the partners power to remove managers;
how much information partners are entitled to receive;
managers fiduciary duties and remedies for breach;
how the managers are compensated; and
the partners power to dissolve the partnership or demand that the firm buy
out their interests.

b. Variations on Partners veto power

Partnership agreement can also amend a partners right to veto extraordinary decisions.
Distinguishing between ordinary and extraordinary acts is usually done by determine
which matters require the approval of all or a supermajority of the partners.
Some large partnerships want to reduce the high costs of having to get unanimous partner
consent.
Limitations: a provision limiting a partners power to veto an extraordinary act or in
contravention of the agreement may be subject to strict interpretation because it alters an
important partner right under the UPA.
Courts can strike down majority-rule action even if it were arguable within the general
majority-rule provision, if it is not clear whether the provision applies and the act
significantly damages the objecting partner or indicates at least a borderline fiduciary
breach by the majority.

Bailey v. Fish & Neave

Extended the length that two leaving partners would get their money. The Partners argue
that something such as changing the way the accounting occurred is extraordinary and
required unanimous consent. However, Partnership agreement said everything, including
dissolution of the firm, was to be done by majority consent.
Purpose of this case is to show that you can contract around even extraordinary
measures.
Note 4-6
1. Majority in interest:
UPA and RUPPApartners have equal voting rights regardless of their economic interest
in the firm.
--you can amend this provision in a partnership agreement.
2. Accounting Issues

c. Varying Partners Authority to Bind the Firm

When partners alter their rights, it becomes difficult to apply when dealing with third
parties.
Third parties must have knowledge of the amendment.
Third parties who actually see the agreement containing the restriction may be bound, but
as in Patel, partners cant always count on the other partners involved.
Since formal filings arent required for partnerships, partners are permitted to file
statements of partnership authority.

Business Organizations Book Outline

As to partners who are authorized, the filed statements give the third parties a safe harbor,
unless there are unfiled limitations, etc. HOWEVER, even if the parties make a filing, the
third party isnt deemed to have knowledge of it. Thus, it is often appropriate to include
such provisions in the partnership agreement that deals with the RUPA-type statement of
partnership authority.
Statements of partnership are significant; however, agreements stating a partners ability to
bind the firm should be in writing.
4. Management and Authority in Limited Partnerships

a. general partners
-a general partner in a limited partnership has the same rights and powers as a general partner
in a general partnership. (right to vote, participate equally in management, and the general
partners power to bind the firm.
Luddington v. Bodenvest Ltd., 855 P.2d 204 (Utah 1993)
Partnerships: Until it filed bankruptcy, Granada was Bodenvests general partner.
Granadas common stock owned by Larsen, who was president and one of its directors.
Bodenvests limited partners were retirement trusts established by Utah medical
practitioners.
Purpose: stated to acquire a parcel of undeveloped real property . . .
The General Partner had the power to borrow money and, if the security is required to do
so, mortgage or lien any portion of the property of the partnership, as the general partner
deems in his absolute discretion.
Granada, by and through Larsen, began a series of three transactions:
a. Petereson investors loaned Granada 455,300;
b. Second trust deed recorded on the property with Luddington for 150,000;
c. Third trust deed the one at issue was to Foothill for 253,083.
2. Bodenvest limited partners had no idea there were liens on the property until Granada
filed for bankruptcy.
3. Here, Granada was encumbering the sole partnership property by taking out loans against
the property. Foothill was the creditor. Thus Foothills either gets the land or gets paid
while Bodenvests limited partners would lose the land because of Granadas dealings. He
used the partnership to get a personal loan.
4. Least Cost Avoider:
Limited partners could have made encumbering assets require a majority vote.
Foothills could have done its due diligence and been express in who
Granada/Larsen was binding when he signed the documents. This shows the
tension between lender agreements and authority of a managing general partner.
5. Here, the Limited Partners were innocent parties.
Larson wore several hats: Individually he was Granada president, Managing
general partner of Bodenvest and Granada;
Understand which hat the party is wearing when they take action.
6. Holding: Granada did not have the actual or apparent authority to encumber the
partnership property to Foothill. The trust deed executed and delivered to Foothill to
secure a loan to the general partner and its president was totally without authorization by
the partnership owner.

Business Organizations Book Outline

7. Dissent: It is not unreasonable for the lender to believe that Granada was operating on
behalf of the partnership. Give both args on final because least cost avoider is hard to
say.
Note 4-7
1. Application of General Partnership Statute
2. Scope of General Partners Authority: self-dealing transactions
UPA and RUPA provide the basic rules on general partners authority, it is not clear
whether these rules should be applied the same way in limited and general partnerships.
The self-dealing problem that general partners often submit to is amplified by the fact
that many general partners serve as promoters for several syndications.
Even when a limited partners knowledge of the general partners activities might
establish estoppel or ratification even if it does not establish apparent authority.
3. Planning considerations: partnership
The partners may attempt to expand general partners authority in the partnership
agreement in order to minimize third parties costs of dealing with the firm and, therefore
the firms cost of doing business.
The partners may also limit the scope of the general partners authority.

b. Limited Partners
Limited partners are not supposed to take part in the ordinary procedures of the business,
i.e. voting; however, RULPA is contradicting:
o 302says a partnership agreement may grant limited partners the right to vote
upon any matter.
(b) safe harbor against inference of control
(b(6) specifies when voting is not considered participation in control of the
business.
o 303(a)a limited partner loses the protection against limited liability if he or she
participates in the control of the business.
ULPA 2001 eliminated the control issue.
i. voting rights

General partners have the same rights as partners under the UPA and RUPA when it comes
to voting due to linkage. UPA 18(e)(h); RUPA 401 (g)(j):
RULPA requires unanimity as to certain matters such as admission of new general or
limited partners; dissolution or continuation of the partnership upon the withdrawal of one
or more of the general partners.
Further, limited partners are to consent with general partners self-dealing.
The RULPA provides that the partnership agreement may grant voting rights to limited
partners.
ULPA 2001:
o Notes that general matters are to be conducted by the general partners only;
however,
o All partners, general and limited, must consent to amendment of the following:
1. Partnership agreement;

Business Organizations Book Outline

2. Amendment of the certificate to add or delete limited liability
limited partnership status; or
3. Disposition of all or substantially all of the partnerships property
other than in the usual and regular course of the limited partnerships
activities.
Fox v. I-10, Ltd., 957 P.2d 1018 (Colo. 1998)
Fox was a limited partner; and MSP was the general partner to I-10, Ltd.
This came down to interpretation of three sections of the partnership agreement:
o (1) 4.09: put a cap on what majority vote could force as capital contribution.
o (2) 7.00: Allowed for a majority vote to amend the articles.
o (3) 7.02: Tackled all other non-routine amendments.
MSP wanted to do a land swap with the state, but there needed to be a unanimous vote to
do this, but they needed more money. Unanimous vote was held to change agreement so
that MSP could a land swap (the agreement only considered buying and selling land).
Fox refused to pay more than 600% of his original capital contribution.
Default rule said that this was a new investment, and thus an extraordinary measure.
However, the contract said only majority was required, and this trumped the default rule.
Thus, Fox had to contribute.
TAKWAWAY: Default rules can be amended and voting can be amended by the
partnership agreement. If youre going to sign into the partnership, make sure the
agreement is something you can agree to.
In Re Nantucket Island Associates Ltd. Partnership Unitholders Litigation
Another case where the agreement had to be interpreted.
4.3 of the PA permitted the MGP to sell additional limited partnerships interests on such
terms and conditions and having such rights and obligations as the managing general
partner shall determine.
o There was a right of first refusal, which permitted other partners to buy the assets
the MGP wanted to sell. Rather than reducing their stock, they had the ability to
increase it.
11.3 of the PA dealt with amendments. It said that certain amendments would be
unanimousincreasing the amount of capital contribution (cf. Fox); extending the
termination date of the partnership; changing the method of accelerating the dates of
capital contributions or increasing the liabilities of the LPs; things adversely
MGP said that 4.3 allowed him to subordinate the limited partners by allowing preferred
partners to enter into the partnership. These preferred partners would get first piece of the
pie on payouts.
Court interprets the articles in the light most favorable to the limited partners because
the GP wrote it.
Finds that there needs to be unanimous agreement of the limited partners to
subordinate them. The subordination is a fundamental change. This isnt a slight
dissolution of your ownership percentage. It is a change in the interest as a whole,
and should require a unanimous vote.
TAKEAWAY: Changes that are fundamental, such as taking away a limited partners interest,
should require unanimous vote because its not just a slight change.

Business Organizations Book Outline

Note 4-8
1. Interpreting limited partnership voting provisions
In re LJM2 Co-Investment, LP., a case involving Enron special purpose entity, imposed
several qualifications on an agreement regarding limited partners voting powers,
including interpreting an agreement providing generally for amendment by majority vote
as note negating the specific statutory default unanimity requirement for amendments of
limited partner obligations.
2. Proxy voting
PA may also provide for proxy voting, at least where the statute permits the agreement to
so provide.
3. Ratification of General Partners Transactions
Limited partners may have voting rights in ratifying conflicting interest and other
potential fiduciary violations by general partners.

ii. the control rule

Historically, a limited partner could not exercise any control over the limited partnership
or he/she would lose his limited status.
ULPA 2001 eliminates the control rule, but it still exists in many states.
RULPA specifies that a limited partner will be denied limited liability if he/she
participates in control of the business.
Under the revised agreement, a limited partner must exercise control with a third party or
someone outside the firm, creating a safe harbor for inter-firm control.
Reasons for the control rule: Potential changes to the tax code; argument that the option
for an LLC is a good example of why we should get rid of the control rulethere are
partnerships and LLCschoose what you want to be (FERSHEE ANALYSIS).
Recognize and understand that the control rule is still alive and well in a number of
jurisdictions.

Gast v. Persinger, 228 Pa. Super. 394, 323 A.2d 371 (1974)
Gast employed by LNG services. Severed his employment after he went unpaid. Suing for
backpay. He is suing the General Partner, but says that two of the LPs took on enough
control to be liable for his claim. The GP is bankrupt, so the LPs are sued also.
Appellant was claiming that limited partners were acting as general partners such that they
are liable in their individual capacity. The Court found that two partners potentially
did act as general partners.
o Two LPs took on control issues as project managers and were described as so on
the booklets. They also acted as independent consultants to the MGP. Their
decisions may have controlled the partnership.
o The Court first looked at their role as project managers. They looked to see if they
took on extra roles because if they had, they planned on acting outside the scope of
the limited partnership. The major problem is that they acted as limited
consultants.
Traditionally, partnerships dont employ the limited partners. The court says that it is not
clear whether the two advised and controlled the decision of hte GP given their technical
training skills.

Business Organizations Book Outline

Example of What does not trump the limited partnership:
You can be a consultant and a limited partner; however, if you operate as a significant
employee than the limited partner protections are absolved. The consultant role must be
limited.
o Acting as a sales manager in a new car sales department without the power to hire
or fire, and with power to order cars only with the GPs approval;
o participating in the choice of key employees and giving a certain degree of advice;
o acting as a member of the board of directors of the partnership;
o the court says the LPs can be there with the board of directors, but they cant take
a lot of authority.
Note 4-9
1. RULPA safe harbor
RULPA 303 contains a list of powers that are granted to limited partners without
triggering the control rule, including:
o the power to consult with and advise a general partner with respect to business;
o and to propose, approve, or disapprove matters related to the business of the
limited partnership which the partnership agreement states in writing may be
subject to the approval or disapproval of limited partners.
2. RULPA reliance requirement
RULPA also provides that even if a limited partner is participating in control that is not
covered under the safe harbor, the third party can only recover from a limited partner if he
has been misled by the limited partners participation in control.
3. Limited partner as officer, director or shareholder of corporate general partner
In order to protect against liability, the limited partner should clearly indicate that she is
acting in a representative capacity for the corporate general partner.
4. Explaining the control rule
The control rule is often associated with signifying that only those with liability can take
management responsibilities. General partners personal liability helps to align their
interests with creditors by giving them an incentive to keep the firm from becoming
insolcent. General partners may be unwilling to agree to be personally liable for the firms
debts without some assurance that they will be able to guard their exposure by continuing
the mange the firm.
The rule gives limited partners to take over as long as theyre willing to be vicariously
liable.
5. the future of the control rule
6. control rule and veil piercing
Controversy between states as to whether the veil can be pierced in partnerships since
this is typically something seen with corporations.

c. Management and Authority in LLCs

The hallmark of partnerships is co-equal right of every partner, absent a contrary
agreement. TO the outside, every partner is always an agent of the partnership if
apparently conducting the usual business of the partnership. On the other hand, a
corporate shareholder has no apparent authority to act on behalf of the corporation absent
the creation of an independent agency relationship.

Business Organizations Book Outline

LLCs accommodate both types of management: the ability to elect between management
by members and management by managers.

1. The management election

Most LLC statutes provide that members are managers unless a contrary agreement.
LLCs can opt out of this management default by provisions in the articles or operating
agreement. DISTINGUISHES LLCs from general partnerships.
Think about agency power of members and managers. Under partnership law, partners are
agents of the partnership for carrying out the business. Every partner can bind the
partnership.
o Must think about the agency powers of members and managers.
Del: has a bias towards a corporate like structure. % of interest is how your
voting rights are determined unless this is contracted around.
If a member signs the agreement, then this tells you the LLC is member
managed and all members can bind the LLC. If the signing with the
manager shows for sure there is a manager with a structure.
In RLLC, we look to agency law to find out whether a party has the
authority to bind the LLC. Delaware says that everyone has the right to
bind regardless of structure.
General partnerships may have more than 1 manager, however LLC statutes clarify
centralized management, including who can bind the firm to third parties and who has
fiduciary duties.
LLC variations:
o Member-managed LLC: functionally like a partnershipeach member has
power to bind and act on behalf of the firm.
o Manager-managed: they move to a corporate structure. Appoint a set group
of people to run the business and only those managers are the people who can
act on behalf of the llcthe non managers allow others to take control of
investment and work for them.
2. Effect of Articles and Operating Agreement
Under ULLCA: the manager managed is filed when you file your LLC that says what type
of structure you have and its on public recovered.
Under RULLCA and Delaware: not required for company to file as part of articles or OA
this means that what type of LLC it is not public record.
Delaware is biased towards corporate structures, which is percentage interest votes, unless
it is changed otherwise through the operating agreement.
Thus between member managed, manager managed, and Delaware, we end up with three
basic structures.
Requiring centralized managed election to be set forth in articles gives some notice to
third parties, whose rights may be affected by the restrictions; however, making the
articles controlling may mislead those who relied on the operating agreement.
3. The Agency Power of Member and Managers

Business Organizations Book Outline

The issue with LLCs and member managed or manager managed is that if they arent filed
in the articles or operating agreement, third parties have no idea of knowing whether a
person can bind the firm.
The application of agency principle in the context of statutory default rules means thata
manager will have actual authority, as a default rule, to commit the LLC to a matter in the
ordinary course of business, and that a third party without reason to believe otherwise
could reasonably believe that manager has the authority contemplated by the statutory
default rule.
As a third party about to sign a contract with an LLC, how are you to know if the person
in front of you is authorized to bind the firm?
o 1) without examining the articles of organization or the operating agreement, you
wouldnt know whether the LLC was managed by managers or members.
o 2) it may not be clear under some statutes whether the statutory default agency
power of a member of a member-managed firm or a manger of a manger-managed
firm is effectively limited or expanded by the operating agreement.
o 3) it may not be clear whether a non-member or a member of a manger managed
LLC can bind the firm despite a statutory provision that purports to empower only
members of member managed firms or managers of a manager managed firms.
o 4) even if you know what kind of firm you are dealing with and the statute controls
regarding whether members and managers can bind the firm and the scope of their
authority, you may not know whether the person you are dealing with is a member
or manager.

How do we know if an LLC Member or Manager is authorized?

When you see a signature block that has a name followed by a member, it tells you that it
is a member managed LLC.
o Depends on the state. If it is ULLCA, then the certificate will tell you. This is a
question we do have for LLCs. What state law will bind at all? As a general matter,
o When we talk about the relationship between shareholders and the company, we
look to the state of incorporation.
o When we look to third parties and corporations, we look to law of location.
When the signature block says manager?
o In ULLCA: we have apparent authority to bind an LLC if someone is a member
only if it is a member-managed LLC. Here, they could look to see what the
structure is.
o RULLCAwe revert to agency law since there is no filing to check. Look at
apparent authority in this case.
o Delaware law- anyone has the right to bind. They take the view that the LLC is the
least cost avoider. They can limit who they work with.
o What happens if you truthfully say that he is the manager, and he is? He may have
actual authority. We can defeat actual by having rules, but if he is in fact the
manager, we expect him to have the authority unless the principle has conveyed
other wise.
How do you draft to reconcile the differences?
o Statements of authority can sometimes effectively limit ability to take on apparent
agency issues depending on if the third party you are dealing with knows about the
relationship. We can create indemnity between members and manager or an

Business Organizations Book Outline

intersection of protection, but as to third parties, we have a trust problembe
careful with who you hire. The agreement helps you avoid implied consentwhen
an agent says I really thought it was ok.
Sometimes we can avoid all of these problems EXCEPT for the fraudulent actor part.
4. Member Voting Rights

4.06 Responsibility for Wrongful Acts

A. Principals Liability for Agents Torts
The standards for holding the principal liable for the agents acts differ when the
interaction is voluntary (typically a contract or other transaction) or involuntary (typically
a tort).
The concepts of express, implied, and apparent authority apply with respect to actions of
agents that bind principals in voluntary transactions; however, those authority principles
do not apply to circumstances in which tort victims, i.e. those with an involuntary
relationship with the agent, seek to hold the principal liable for the injuries suffered.
Whether a principal can be liable for the tortious acts of an agent turns on two questions:
o (1) was the agent an employee, rather than an independent contractor agent?
o (2) was the employee acting within the scope of employment?
1. The status as employee
If the tort is within the scope of employment, the principal is liable.
2. The scope of employment
Restatement Third of Agency:
o An employer is liable for the tortious activity of an agent when he/she is acting
within the scope of employment.
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
employers control.
An employees 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 employment.
General Rules Regarding the Scope of Employment
1. Was the conduct of the same general nature as, or related to, the job the employee was
hired to do?
2. Was the conduct substantially removed from the authorized time and space limits of the
employment?
3. Frolic and detour
o If the worker stops to get a drink at a gas station then hits someone, this likely falls
within the scope of employment;
o If employee takes a vehicle to an event that is not part of his job, we will follow
frolic and detour.
4. Was the conduct motivated at least in part by a purpose to serve the employer/principal?
o It is not a defense to say I didnt hire him to run people over with the bread truck
o If an employee spills hot soup on someone, the principle is liable. Customers are
given some level of protection.

Business Organizations Book Outline

o If a contractor is hired to put a roof on your house and the contractor drops a
wrench off the roof and it hits someone, are you liable? Independent contractor is a
conclusion relationship.
5. Watch out for independent contractors being hired for specific purposes (i.e. brick layer)
o Apparent authority-telling brick company, my mason is going to come pick these
up
If he runs somebody over driving back to your house, how could you argue
liability (although there probably isnt)?
Extent or control of the details of the work;
Extent of the business;
Supervision;
Supply of tools;
Skill required for the job;
Method of paymentby hour/by the job?
Scope of employmentnot just the things you ask the person to do
Jackson v. Righter, 891 P.2d 1387 (Utah 1995)
FACTS: Mrs. Jackson is hired by Mr. Righter and began making sexual gestures at her.
She broke off the relationship with Mr. Righter and started having a relationship with her
new supervisor. Husband found out, they tried to reconcile her marriage, she then went
back and started sleeping with her boss again. Her husband sued the company based on
vicarious liability and negligent supervision because of his intentional infliction of
emotional distress.
ISSUE: Was he acting in the scope of his employment?
RULE TO FOLLOW: Court says the employees conduct must (1) be within the general
kind of work the employee is employed to perform; (2) occur within the hours of
employees work and the ordinary spatial boundaries of the employment; (3) be
motivated, at least in part, by the purpose of serving the employers interest.
o Court says: he was not hired to do this and it is so far off from what we hired him
to do, therefore reasonable minds couldnt differ;
o He is advancing his own agenda, whether that agenda is anyone related to his
employers agenda is a different question; the real answerbecause it is so far
beyond the scope of his employment, no one could reasonably say that he was
employed to do this.
o Court says that just because is was on a business trip, not everything he did on that
trip was business related.
Employment Negligent Supervision
Court says that employers have no duty to determine marital status of employees or
monitor their personal relationships.
We pay more attention to these relationships in some instances: resident halls,
teacher/student, etc.
The court basically says on page 169 that if for example we have violent tendencies
(where the employer became aware of his conduct), the employer could be liable.
Court says to look at the quality of the marriage before the relationship happened.
Basically look at consensual relationships. In a marriage, the fidelity to one another

Business Organizations Book Outline

is between the parties to the marriage, it is not an employers job to protect their
relationship.
Mains v. II Morrow, Inc
Millian v. Dean Witter Reynolds, Inc.
FACTS: Millian opened two brokerage accounts at Dean Witter-one for herself and the
other as a trustee for her son, Jamiesusing her other son Miguel as her broker. Miguel
systematically looted his mothers account ultimately stealing from her more than
$287,000. He managed to do this by opening and additional account in his mothers name
and forging her signature on the application.
o The things that he is doing are clearly not motivated by his job.
o She starts depositing money into her account, the son changes her address at the
post office and starts receiving her checks, opens a credit account, etc.
Even if a random person hired her son to do this, is this the same outcome?
o The court implies yes. He is acting so far outside the scope of his employment.
o Court seems hung up on the fact that it is a mother/son relationship.
o Really turns on the point that Dean Witter was reaping the benefits, but the court
still doesnt find them liable. Case doesnt sit well as a general matter. In Fershees
opinion, there is one explanation:
o There is a big issue that he is stealing his moms money. Potential implications
about that.
Court also argues that she should have known earlier.
DISSENT HERE: Important because the dissent is saying that Dean Witter should have
been liable and protected their customers from liability.
Fershee says that this case is not entirely wrong. The relationship between mom and son
certainly colors the analysis. She is the best cost avoider. She is in the position to know.
Note 4-13
1. Scope of employment
The policy questions is whether employers liability for employees torts is an extra cost
the business should bear.
In general, whether liability is socially justified depends on whether the costs of reducing
socially desirable activities outweigh the benefit of reducing accident costs.
o This depends on whether the business causes the wrong or whether the employer
can reduce the probability of its occurring through incentive contracts with
employees.
2. Frolic and Detour whether the EE was on her masters business at the time of the harm.
3. The Bushey Cases
4. Principals direct liability
5. liability under employment discrimination laws

3. Principals liability for acts of non-employee agents

Sometimes agents can be liable for acts of independent contractor agents who are not
employees.

Business Organizations Book Outline

Restatement Third of Agency: a principal required by contract or otherwise by law to

protect another cannot avoid liability by delegating performance of the duty, whether or
not the delegate is an agent.

Anderson v. Marathon Petroleum Company

FACTS: Marathon hired Tri-Kote to have people clean out their oil storage tanks
bysandblasting. Anderson worked for Tri-Kote for 13 years and ended up dying from silicosis.
Wife sued Marathon saying that they knew they were employing people to do an inherently
dangerous activity and they were also aware that Tri-Kote wasnt properly protecting their
companies. Supervisors of Marathon often saw Tri Kote employees coming out with sand on
their face and they knew that Tri-Kote had supplied Anderson with just the patently
inadequate desert hood. Two other employees who came on the scene before Anderson also
died of silicosis. The argument here is that Marathon should have better supervised their
contractors.
ISSUE: Tort duty of a principle to the employees of his independent contractor?
Duty could be vicarious or direct: vicarious if the principal is not himself at fault in the
accident to the employee, direct if he is
Generally, a principal is not liable for the actiosn of independent contractors even if they
are conducted in the scope of the business. However, under the doctrine of superior
respondent, a principle is liable for the torts of his employees if they are committed
within the scope of his employment.
The reason for distinguishing independent contractors and employees:
o By definition, the principal does not supervise the details of the contractors work
and therefore is not in a good position to prevent negligent performance.
o The Independent contractor commits himself to providing a specified output and
the principal monitors overall performance, not by monitoring inputs.
o THIS MODEL does not work if the output consists of joint product of many
separate producers whose specific contributions are difficult to disentangle. In
these cases, the principal should monitor the inputs more closely.
o Employees are distinguishable because they receive payment for the input,
not the outcome of their work.
The main reason for not making principals liable for the torts of their independent
contractor: typically, principals hire contractors to complete jobs theyre not familiar
with, thus they are not in the right place to monitor the inputs of the contracted employees.
DEFAULT RULE: We dont want to make Marathon liable for Tri-Kote because they are
paying for a result. Not how they preform their operations, but for what they produce.
EXCEPTIONS: Restatement Second of Tortsthe default rule is not applied when the
activity is inherently dangerous. i.e. if the activity might very well result in injury even if
conducted with all due skill and caution.
o The agent, principal, and independent contractor are charged with racking their
brains to make sure the task is completed in the safest way possible.
o Also, the people who have authorized the activity (the principal) should forecast
on precautions that can be taken to prevent accidents.
POLICY: The exception is in place to prevent principals from contracting all of their
dangerous activities out in order to avoid tort liability.
Holding: Marathon not held liable for Andersons injuries.
ANALYSIS:

Business Organizations Book Outline

o With rare exceptions, the cases that make principals vicariously liable for torts of
their independent contracts involve injuries to third parties rather than
contracted employees, General thought, but not uniform view, is that employees
have no tort right against principals in those cases.
Example: If Anderson is sandblasting and turns around and sandblasts a
little kid that ran into the area? Tri-Kote has no money; parents sue
Marathonsame outcome? No. This would be a third party injury.
Indicates that Marathon might be liable for this action. Case implies that
there is at least a chance.
o Argument for Workers Compensation: If you get injured on the job, you have a
base level of compensation in return for not being able to sue an employer.
Posner argues that since Tri-Kote was employed by Marathon, allowing
Mr. Andersons widow to sue Tri-Kote would be no different than allowing
her to sue Tri-Kote.
Some level of dangerous activities changes the situation for courts and
applying the workers comp act. Here the activity was relatively dangerous.
o Principal Contractor Relationship monitors outputs not inputs. (Did you do what I
told you to do?)
This changes depending on if youre paying someone a wage or a price for
a total output. Even if it is not an abnormally dangerous activity,
relationship is fundamentally different between an employee being injured
and a third party.
Should Tri-Kote have seen the job as potential risk? Yes. Should Marathon have seen
that? Yes.
o Who should take precautions to prevent? Probably tri-kote because they are
independent contractor to marathon and it was their employee. Tri-Kote also has
workers comp. and they provided an insufficient mask and gear. Tri-Kote sets up
where their employees go; what jobs they do; etc. Tri Kote also has the ability to
sayhere is your mask, if you dont wear it, youre in trouble.
How Could this be a contract problem? Mr. Anderson signed up to do this type of work.
What if Anderson turned around and started blasting people? Is there any relationship
between Anderson, tri-kote, and the third party? Contractual relationship tells who could
have made cost avoiding steps. True third parties cant do anything about these types of
torts. Both Marathon and Tri-Kote have a significant opportunity to protect third parties.
If they determine that this was an inherently dangerous job, Marathon cant disclaim no
liability-period. Sometimes itll depend on how many contractors they do have, etc.
o Unnecessary risks- things that create a peculiar harm to other unless precautions
are taken.
Posner says that Anderson is not a third party, he is a sub-agent, so there is not harm, but if
another was harmed that was disconnected from either party, marathon could have liability
placed on them.
Posner agrees that a very high degree of care is cost justified, the principal and the
independent contractor should be charged with racking their brain. Posner doesnt agree
that this is abnormally dangerous, but believes that there are cases where it could be.
Posner says the reason for distinguishing the independent contractor from the employee
is that the principal does not supervise the details of the independent contractors
work and therefore is not in a good position to prevent negligent performance.
Exceptions:

Business Organizations Book Outline

Principal retains control over the aspect of the work in which the tort occurs;
o Principal engages an incompetent contractor;
Non-delegable duty;
Activity contracted for is a nuisance per se

Majestic Realty v. Toti Contracting

Facts: Employee of independent contractor goofed in demolishing a building, causing
damage to a neighboring structure with a wrecking ball.
General Rule: Principal is not liable for torts committed by an independent contractor or
employees thereof.
Recap: Evolution of Intentional Torts and Scope of Employment Rules
What if we are dealing with a true, unconnected third party?

In early common law, intentional torts were beyond the scope of employment.
Then we revolutionized and now we see that some torts are within the scope of
employment.
Restatement: intentional torts involving the use of force result in liability if use of force
not unexpected by master
Restatement: Consciously criminal or tortious acts not per se excluded from the scope of
employment.
When we think about intentional torts, we think about minimizing the risk or loss or the
overall loss.

Note 4-14
1. Non-employee agents and the economic theory of the firm
Restatement Third of Agency- distinguishes between mere control and the right to control
the manner and means of the agents performance of work.
o This rules helps the typical firm. The distinction between who are and who are not
employees is especially important for law firms. Contacts differ fundamentally
between employee agents and non-employees.
2. Employees and agents
Test for non-employee agents in the Restatement includes control and benefit factors that
are similar to the test for agency. This becomes confusing in cases.
o Example:
Warren in Cargill had committed a tord, the issue might have been whether
Warren was an independent contractor. Despite the confusion, the issues
are separate: an independent contractor may or may not be an agent and
an agent may or may not be an independent contractor.
In Anderson, Tri-Kote was probably not even Marathons agent, but even if
the facts had been such as to support agency, the agent could still be an
independent contractor separated enough from the principals business that
the principal should not be liable for the tortious acts.
3. Non-delegable duties

Business Organizations Book Outline

Anderson shows that a principal may choose to delegate potential responsibility for torts
to an independent business, this delegation is not determinative if it falls within one of the
exceptions discussed in Anderson.
Exception is now in the Restatementinvolves a situation in which the defendant might
otherwise be tempted to delegate control solely to avoid tort responsibility.

B. Partners Wrongful Acts

Partners may bind partnership not only with contracts, but by committing fraudulent,
tortious or other misconduct. Liability depends on whether the activity was in the
general course of the business.
When a principal is asked to answer for the consensual transactions of an agent, we focus
on the authority of the agent.
When a principal is asked to answer for the wrongful acts of an agent, we focus on the
nature of the relationship.
Similarly, UPA and RUPA make the partnership liable if the partner aced in the ordinary
course of the business of the partners or if it occurred within the authority of the
partnership.
The Key distinction concerns the appearance to third parties. UPA and RUPA look at
how the usual way or the ordinary course appears, or the objective reasonableness of a
voluntary creditors assumption that the partner is carrying on the business in the usual
way. (See Problem 2 on Page 185 to work through apparent authority and the application
of UPA and RUPA for wrongful acts).
In Zimmerman v. HoggGreen, Hogg, and Allen law firm represented Holly farms, major
chicken producer. Green (former senior partner), also did occasional brokering of shares
for Zimmerman, an officer and employee at Holly farms. When one of Greens clients
wanted to unload some of his stock in KFC Corporation (to keep his wife from getting in
in the divorce), Green arranged the sale of the stock to Zimmerman, collected $24K from
Zimmerman, but never delivered the stock. Court focued on Zimmermans reasonable
impression that the brokering of shares was the kidn of things that the law firm often did
for clients.
o HOLDING: NCSC found this evidence sufficient to impose liability on the firm,
not because it was in the ordinary course of the business under UPA 13, but
because Mr. Green received the money under apparent authority and misapplied it,
creating a cause of action under UPA 14(a).

Note 4-15
1. Who is liable for fraudulent act?
First American Title Ins. V. Lawsonheld that a law partners misrepresentations of the
absence of wrongdoing in connection with an application for malpractice policy subjected
the firm to recession of its policy where two of three partners participated in wrongdoing,
but did not result in loss of coverage for innocent partner:
o Noted that the innocent partner did not participate in the fraudulent conduct; he
was a distant partner in the sense that he didnt share offices and worked in a
separate Manhattan office alone; was not familiar with the firms trust-account
ledger or with similar records that the fraudulent partner maintained as managing
partner.

Business Organizations Book Outline

o The Court also noted that voiding coverage would make Snyder and his clients
liable, when really Snyder did not do any wrong.
2. Planning and Drafting Implications
In wrongful act cases, the court often looks to the partnership agreement and the partners
scope of business.
WHAT NOT TO DO: PCO, Inc. v. Christian . . . LLP- The Court held that Robert Shapiro
(Ojs defense lawyer) could be deemed to be acting in the scope of his employment when
he improperly obtained bags of cash from his clients house that the plaintiff claimed.
Shapiro said that he represented the criminal in his criminal law practice aside from the
defendants practice. Court held that he wasnt acting separate from the firm because:
o (1) Website promoted Shapiro as the head of the firms white-collar criminal
defense practice
o (2) His name was in the firms name;
o (3) Retainer agreement signed with the firms name on it is also signed by Shapiro;
and
o (4) Shapiro, on record, admitted to representing the firm.
Issue between UPA 13 and UPA 14 is further discussed in the following cases:
o Health v. Craighill . . .P.A.declined to hold a firm liable for a former partners
failure to make a good investment deal for the client. Clarkson had don legal work
for Heath and he subsequently solicited investments in forieng oil deals. Before the
last round of investments, Clarkson had withdrawn from the firm, but was allowed
to remain in the office for a period of time. When notes were due to Heath,
Clarkson paid with a personal check that bounced, and he personally declared
bankruptcy. Court declined to follow Zimmerman and held that Clarksons
dealings with Heath were not within the scope of authority or apparent authority
conferred on Clarkson but his firm.
3. Fraud on the Partnership Exception
UPA 12broadly attributes to the partnership a partners knowledge and notice of any
matter relating to partnership affairs, except in the case of a fraud on the partnership
committed by or with the consent of that partner.
o This exception lets the partnership sue a defrauding partner, and avoids the
odd result in which the knowledge of the wrongdoing partner would defeat the
fraud action.
FDIC v. Jeff Miller StablesSteve was the CEO of a failed bank, had
embezzeled millions and went to prision. FDIC found out that he had used
some of the embezelled moeny to purchase a horseracing stable, where
Steve and his brother Jeff were general partners. FDIC successful brought
an unjust enrichment claim against the partnership.
Holding: the innocent partner Jeff was vicariously liable.
Concurring opinion: Observed that Section 12 was not a defense to
unjust enrichment or the vicarious liability claims, even if Jeff were
innocent because the partnership benefited from the fraud.
Dissent: Partnership was liable, but Jeff was relieved of liability
because Steve had committed fraud.

Business Organizations Book Outline

Chapter 5: Financial Rights

5.01 Introduction
-Chapter discusses capital contribution and the relationship between partners compensation
and loss sharing liability.

5.02 Partnership
A. Financial Rights in General
Default rule: Partners share equally in partnership profits, and share losses equally (or in
proportion to profits if the partners agree to share profits unequally).
Profits and losses are divided up on dissolution of the partnership, which occurs, among
other times, when a partner leaves.
During the partnerships operation, partners have no statutory right to distributions
during the firms operation, although the partnership agreement may provide for such
a right.
The default rule means that partners receive no extra compensation for contributions of
money or services, unless otherwise agreed to in the partnership agreement.
Partners are often surprised by the equal sharing rule when theyve contributed a lot of
time, but not money to the partnership.
B. Financial Contributions
Partners can make two types of financial contributions: (1) capital contribution; (2) by
loan
o Loans usually have scheduled repayments and periodic interest payments.
o Capital contributions are more of a commitment to the firm that may not be repaid
until dissolution and that is taken into account in determining the partners profit
share.
Partners arent required to make financial contributions; service partners do exist.
Partners sometimes also have continuing obligations to make financial contributions after
dissolution.

1. Partnerships and Individual Property

In a formally organized partnership, the agreement usually specifies partnership property,
including partners contributions to the firm.
In informal partnerships, it may not be clear whether the partnership, or one of the
individuals.
UPA and RUPA establish presumptions to help determine what the partnership owns:
o The partnership owns property purchased with partnership funds, and RUPA
counter-presumption is that property titled in the individual partners is not
partnership property.
o But RUPA also provides that the partnership is presumed to own property
purchased with partnership funds even if the property is held in the partners
individual names.
When partnerships business is to own and operate an asset (like real estate) the question of
what the partnership owns is closely related to whether there is a partnership at all.

Business Organizations Book Outline

Matter of Woolstonthe court held that a mobile home park, development of which was
the partnerships sole business, was the property of individual parnters based on the
partners use of individual funds, loans, and deeds in individual names, and strong
evidence of partners belief that they owned property as individuals. (thus no partnership
existed)
2. Compensation for Financial Contributions
Partnership statutes assume partners are compensated for capital contributions (such as
credit and services) through their equal profit share.
Partners may receive extra compensation for contributions in addition to capital (such as
loans) in the form of interest.

C. Service Contributions
Partners have no default right to extra compensation for their services in addition to their
capital. Different from agents.

1. Default Rules and Implied Agreements

Default rules often fail to take account for the partners different investments of both
capital and time.
Courts occasionally imply agreements to vary the default rules.
Walker v. WalkerCourt awarded fees partly because of the size and complexity of the
farming operation managed by one of the partners.
Warren v. Warrenheld that partners who provided substantial time and vital services
deserved extra compensation.
2. Alternative Compensation
Partners are free to contract for compensation schemes of their choice.
a. Business Considerations
In contracting for compensation in professional firms, parties must try to avoid several
types of costs:
o Shirking: Issue of working in teams; if partners arent directly awarded for their
contributions, they may start to free ride. Shirking is through appropriate
compensation agreements and by the market for lawyers services and expulsion
provisions in the partnership agreement.
The best way to avoid shirking is to award partners directly for their work;
however, this is not always efficient because sometimes a client, etc comes
for the reputation and not a general person.
o Risk-bearing costs: some methods of disciplining shirking by rewarding partner
effort may not work b/c they expose partners to substantial risks to their earning
potential over which they have no control. For example, if a partner is
compensated for billable hours, the pay is subject to market fluctuations.
Some law firms pay partners solely by seniority in the firm, but this brings
the shirking issue back into play.
o Administrative Costs: A partnership agreement that perfectly rewards partners
contributions would probably involve administrative costs that exceed the benefits
in terms of partner productivity.

Business Organizations Book Outline

o Opportunism Costs: A compensation system that minimizes the other costs
discussed above may allow partners to act opportunisticallyto take advantage of
their co-partners.
Ex: partners who benefit from seniority based compensation when their
specialty is out of favor may decide to leave for another firm with clients as
soon as their specialty becomes hot. Law firms can avoid this by tying
client relationships to the firm rather than a specific partner. However, it is
hard to make partners give up their general client list for the cause of
developing the firm since this makes it harder for lawyers to get higher
rankings at other firms.

b. Legal Considerations
Even when partners reach an agreement, they must put it in writing that is feasible.
Courts may imply fiduciary or good faith duties that the parties may or may not
have anticipated.

Star v. Fordham, 20 Mass. 178, 648 N.E.2d 1261 (1995)

FACTS: Plaintiff was initially a partner of one Foley and Hoag. He was thinking about
leaving the firm and a partner from Fordham and Starrett asked him to join the firm they were
all thinking about starting. Star was worried about leaving the firm because he wasnt a rain
maker at his current firm. Fordham ensured him that that wouldnt go into calculating
profits. Timeline is important:
o Starr leaves Foley March 1, 1985;
o New partners leave Foley March 4, 1985;
o Signs the partnership agreement March 5, 1985.
o Prior to executing the partnership agreement, Plaintiff informed Fordham that
certain parts of the agreement disturbed him because it gave the founding partners
the ability to determine what profits would be allocated to each partner. Plaintiff
ended up signing the agreement with making no problems after being told to take
it or leave it.
The timeline is important because the other partners coerced him to leave the firm, they
left after him, and then didnt give him any leverage in amending the partnership
agreement.
He dissociated from the firm, and he was given 6% of the profits per the dissociation
agreement.
HOLDING: The court found that the partners violated the covenant of good faith and fair
dealing. They had been distributing profits according to money brought in, and Starr had
brought in 11% of the business, so he should have been given that amount.
Also, the court found that the partnership made a misrepresentation to the plaintiff
regarding how partnership profits were going to be paid out. This was a tortious
misrepresentation.
Law Firm Payment Options:
Lockstep- each person gets the same baesd on what level;
o Benefit: people will be more willing to work together and sent clients to other
associates.
o Risk: free ridersshirking; losing incentive; to work harder and bring in clients
Eat what you kill.

Business Organizations Book Outline

o People are less likely to work together and be more in it for themselves rather the
firm.
Note 5-1
1. Interpreting the contract
2. Business Considerations
The agreement could have been bad for the plaintiff because if he had doing well, the
other partners would have had little reason to incentivize him.
3. The role of misinterpretations
4. Law firm partnership and economics
Take the following firm for example:
o 80 partners and 120 associates.
o Associates work on avg. 2,000hrs/yr. At 250/hrgenerating a revenue of 60
million.
o Partners bill an average of 1500hrs/yr at $500/hr. The partners therefore also
generate 60million in revenue (they have administrative and rain-making duties
that take up time)
o COSTS:
Starting Associates salaries: 160,000/yr.
Avg associate pay 250,000/yr.
Fringe benefits at a rate of 27% of total compensation.
o TOTAL ASSOCIATE COST: 38.1 million per year.
o ALL OTHER COSTS: 40million.
o TOTAL PROFIT 41.9 million, or roughly $525k per partnerif equal
compensation rule applied. Aside from the equal compensation, other commonly
used in law firms:
1. Assigning varying points or units of profit participation to the parnters
based on several indicia of partner productivity.
2. Having a managing partner or committee of partners allocate profits based
on their evaluation of parnters contribution;
3. Pay that rises with a partners seniority in the firm;
4. A profit center approach that bills and credits to the partners their shares
of revenue and expenses items.

5.03 Limited Partnership

Informal or unstated compensation agreements are unlikely with limited partnerships.

As long as the limited partnership complies with the requirements for filing a certificate, it
is formed and while both RULPA and UPLA permit oral limited partnership
agreements, the practical reality is that informal or oral limited partnerships are unlikely.
Most limited partnerships are tax driven.

A. Contributions
How a person comes to be a limited partner highlights the nature of the limited partnership
as a deliberate relationship.
There is no default rule for characterizing a person as a limited partner after the fact.
RULPA 101(6)a limited partner is simply a person who has been admitted to the
partnership as a limited partner pursuant to the partnership agreement.

Business Organizations Book Outline

ULPA 2001provide that a person may also become a limited partner as the result of
merger or conversion or with the consent of the partner.
RULPAnotes that contributions can be in cash, property, or services rendered, or a
promissory note or other obligation to provide any of those.
ULPAliberalizes the contribution requirement even more by providing that the
contribution may consist of tangible or intangible property or other benefit to the
partnership, including cash, services, notes or other agreements to contribute to assets or
perform services.
B. Sharing of Profits, Losses, or Distributions
RULPAprovides that limited and general partners share profits, losses and distributions
according to their capital contributions to the firm in the absence of contrary agreement.
ULPA 2001- eliminates the allocation of profits and losses.
Both RULPA and ULPA require LPs to maintain records of the value of
contributions upon which sharing is determined.
Unlike GPs, LPs do not have the presumption of not compensating the partners.
Also, limited partners may be obliged to return profits and distributions for the
benefit of creditors of the limited partnership.

5.04 Limited Liability Company

A. Allocation of Financial Interests
The statutes differ regarding the rules of financial rights.
ULLCA and RULLCA have a partnership type equal allocation rule among the
members.
B. Member Contributions
Similar to limited partnerships and corporations, one usually becomes a member of an
LLC upon some sort of contribution.
C. Members Individual Liability to Creditors of the Firm
Members are offered corporate style limited liability.
LLC members may be liable to creditors under several circumstances:
o When members themselves have committed actionable wrongs;
o For debts the members contractually assume or guarantee; and
o on account of unpaid contributions or excessive distributions.
Most statutes provide that members must leave some money in the firm for creditors.
A member whose contribution obligation is compromised by consent of the other
members nevertheless may have to honor the original promise for the benefit of creditors
who extended credit in reliance on the contribution before being notified of the
compromise.
many firms distribute most of their income, thus creditors have little protection to
insolvent firms.
Note 5-2
1. Initial Contributions
Operating agreements usually list the amount, value, and time of each members initial
contribution or obligation. Contributions are investments, thus they do not earn
interest like a loan.
2. Additional Contributions

Business Organizations Book Outline

The OA may provide for additional contributions. This may increase the voting power nad
financial rights of members who make them.
LLCs can put a protection in to make sure that members dont give more money in order
to take over control by putting in provisions that say additional contributions are only
made when they are called for by managers, and then in only proportion to their existing
financial shares. Agreements may also provide that additional contributions can be
required or assessed.
Litigation arises when members dont want to give additional capital. A members
status, without other terms, does not obligate him to make additional capital.
o In one case, the Court held that a managing member who had loaned money to the
LLC was permitted to issue a capital call so the LLC could repay him since
nothing in the agreement prohibited him from issuing the capital call for that
purpose.
o In another case, the Court held that the capital call provision in agreement could
not be used as basis for satisfying judgment against LLC for unpaid insurance
premiums because members contractual assumption of statutory limited liability
must be provided for unequivocally.
o In another case, under Delaware Lawliquidated damages provision in the
operating agreement did not exclude other remedies for breach of contract to make
the contribution.
o Other cases have held that members are not obligated to fund an LLC without a
prior agreement to do so; and in another case the court held that the partnership
agreement provided expressly for failure to make capital contributions by making
the sole remedy the dissolution of the partnership.
In Related Westpac LLC v. JER Snowmass LLC the operating member, Related, sued the
money member, JER Snowmass, over the latters refusal to respond to a capital call. The
Court dismissed the complaint.
o Court stated that Related relinquished any reasonableness condition and proceeded
knowing that if JER Snowmass did not view things in its best interest, JER could
solely refuse to give consent. Related asked the Court to view everything in the
Operating Agreement to a reasonableness condition.
3. Capital Accounts
LLC OAs normally provide for the maintenance of capital accounts. Capital
Accounts track members gains, distributions to other members, and members shares of
losses and other negative adjustments.
4. Allocations of Profits and Losses
ULLCAinterim distributions (which must be approved by all members) must be equal
in shares.
No explicit statutory default rule for allocating profits and losses in the absence of an
interim distribution.
In a comment to the ULPA it notes that the act directly apportions the right to receive
distributions. Nearly all limited partnerships will decide to allocate profits and losses in
order to comply with applicable tax, accounting, and other regulatory requirements.
Members can also agree to establish different classes of interests, with one class being
used as a stock option to be awarded as compensation.
It is important to note that LLCs are entirely dependent on the operating agreement
with really flexible.
5. Interim Distributions

Business Organizations Book Outline

Distributions made prior to a partners withdrawal are called interim distributions.

Interim distributions are usually left to a partners discretion;
The agreement may clarify the basis on which the decision is madeas when cash
exceeds current and anticipated needs for operations, interest on debt and so forth.
The agreement may clarify managers duty to declare distributions, if possible, to fund
members tax liabilities for the firms profits. The agreement may also provide for
agreement among the partners on tax issues.
The statutes normally provide that members are not entitled to distributions of
property and cannot be forced to accept such distributions of property
disproportionately to their ownership interests. The agreement may also give managers
discretion to make in kind distributions, in order to avoid an untimely sale of assets.
Agreement may be drafted to prevent a distribution from exceeding a members tax basis
in the LLC interest.
The agreement may include statutory limitations on distributions when liabilities
exceed assets, to clarify that members have no rights among themselves to distributions in
this situation irrespective of whether such distributions may otherwise be permitted by the
agreement.
6. Creditors rights to enforce contribution obligations
Creditors may step in and claim that they are third party beneficiaries of members
original contribution promises.
Limited Partnership case law may be applied in interpreting closely similar LLC creditor
protection provisions.
Members can try to block creditors with provisions in the operating agreement; however,
the Court typically ignores these attempts and makes members liable for creditors.
7. Application of bankruptcy law
A bankrupt partnerships trustee in bankruptcy may enforce partners contribution
obligations, while creditors may be stayed, or mere likely enjoined from collecting
partnership debts from individual partners.

5.05 The Role of Financial Accounting

A. Using Capital Accounts to Track Owner Equity {SKIP}
Partnerships and LLCs take an accounting approach that is fundamentally different from
corporations.
o Corporations use an entity approach that focuses on the wealth changes of the
firm.
o LLCs use an aggregate approach that focuses on the wealth changes of individual
owners.
Partnerships and LLCs: each partner or member has a capital account.
Corporations: share of stock is a claim on a portion of the share of the firms assets that is
collected to the class of stock the holder owns. This is represented on the firms balance
sheet, just like the owners capital accounts.
The main difference is corporate shareholders interests are represented by shares that
are convenient for trading. Whereas partners or members accounts are individualized
rather than part of a class as in a corporation.
In the most basic sense, capital accounts are part of financial accounting for the
partnership or LLC that initially reflect cash and the fair market value of property
contributed by the owners and which are adjusted overtime upward to reflect the owners

Business Organizations Book Outline

shares of profits and additional owner contributions and downward to reflect the owners
shares of losses and distributions to and withdrawals by the owners.
B. A primer on financial accounting {SKIP}

1. The Fundamental Equation: Assets=Liabilities + Owners Equity

The four main pieces of financial statements are (1) the balance sheet, which is static and
shows the assets, liabilities, and equity of the firm at a single moment in time (snapshot);
(2) the income (or profits and losses) statement, which is dynamic, and shows the results
over a period of time; (3) a statement of cash flows, which differs from the income
statement in ways mostly not relevant to the current discussions; (4) the statement of
owners equity.
The trick to keeping the equation balanced is double entry bookkeeping or double entry
accounting which makes sure that every transaction in or out is accounted for for in
dollars with two entries somewhere in the financial statement.
Assumptions that are generally true in accounting:
1. The entity being accounted for is distinct from those who own it, whether
or not its a separate legal entity.
2. The entity is a going concernmeaning liquidation is not expected
anytime soon.
3. The entitys activities can be attributed to time periods such as months,
years, or quarters.
4. The transactions being reported must be capable of measurement in money
based on some real transactions;
5. Items of expense should be matched to the period in which those expenses
contribute to the generation of income. This is important for long-term
assets that take more than a single year to use up. Such assets are deemed
to depreciate in an amount that is considered to be an expense during the
relevant accounting period.
6. Accountants are conservative and want to guard against firms natural
tendency to overstate their value to others. They therefore prefer to
understate earnings, values, and cash flows rather than overstate them.
7. Firms report assets at their historical cost, not their market value.
In a balance sheet, assets are listed on the left and liabilities & equity are listed on the
right.
o Typical assets include cash to marketable securities, accounts receivable,
inventory, equipment, facilities and land.
o Typical liability accounts include: accounts payable, notes payable, and long-term
debt.
o Typical expense accounts include cost of goods sold, salaries, and rent.
o Typical revenue accounts include sales or fee revenue.
GAAP: Generally Accepted Accounting Principlesset of rules and standards for
accounting.
Accounting is typically done on the accrual basis.they attribute income and expense to
the period in which the legal obligations form, not when the cash exchanges hands.
In cash based accounting- revenues and expenses are recorded only when the cash goes
in and out.
2. A simple example of Accounting for Owner Capital Accounts

Business Organizations Book Outline

C. Tax Issues
A partner who contributes property to the partnership dose not at that time have to pay tax
on appreciation in the value of property since she bought it. The partner continues to have
the same tax base in the propertythe amount that is used for determining any eventual
taxable gain on the propertyeven after contributing it to the partnership. When the
property is sold, appreciation over this basis is taxed to the partner.
D. Accounting, Tax, and Contract Interpretation in the Real World
The owners often agree n the partnership or operating agreement on how to allocate
money and tax consequences. They can agree on their accounting method and
distributions to partners upon dissolution.
Darr v. D.R.S. Investments, 232 Neb. 507, 441 N.W.2d 197 (1989)
FACTS: P and James Stephens and Erwin Rung were in a partnership agreement known
as D.R.S. invetments (DRS). Each partner contributed $1,500.00 in cash to the
partnership. Partnership purpose was to build, sell, and dispose of property. They built on
land owned by JED Construction. Partnership Agreement: provided for equal sharing of
profits and net losses, the ame to be credited or charged to the drawing account of each
partner. The agreement further provided that the books were to be maintained on a
cah basis and closed on December 31 of each year. Darr says he wants to retire, pay up.
He gives them notice and they pay him $1,500.00. During the time of the business, the
accounting changed from cash to accrual basis and this placed each partner in the
negative.
They made this switch for income tax purposes so they could take advantage of the losses.
Nothing to do with how the company ran.
An attorney for the partnership drafted the agreement, thus he worked for the partnership.
After he turned down the agreement, the partners clamed that Darr owned them money
since they were all in loss and sharing profits and losses. It is important to note that
they changed this and operated under it before he decided to retire.
In 1982, there is a balance sheet with $1,004,500.00, but the capital accounts are still
$1,500.00
Partners shall get the amount of their capital account, thus it doesnt change the outcome.
HOW COULD AGREEMENT BE CHANGED TO MAKE SURE THAT HE CAN
SHARE IN SOME OF THE VALUE? Here, if theyd have a rental property, theyd have a
lot of money coming in so it wouldnt be fair for them to only pay him $1500.00.

Business Organizations Book Outline

Making it a market value assessment can incentivize partners to act poorly.

The clause here may have some punitive effect, but it may be the intent at the outset to
stop partners from bailing.
Holding: The Court ends up saying that the capital account language is not
ambiguous and doesnt include depreciated value, but at the same time his
retirement should be calculated on the cash basis as they agreed to. The Court says it
was wrong to use accrual method because that method was enacted, it was never
meant to modify the retirement option.
POLICY: Courts dont like to reform agreements UNLESS there is a writing error,
mutual assent error. Agreements are entered into to be upheld, even if parties dont like
the outcome, courts will not reform agreements.
NOTE: A lot of people run property businesses for a loss. If it isnt the primary income
generator, there are benefits in claiming losses.
Problem with using the capital account for payment on dissociation is that it does not take
into account the appreciation of certain assets. This may be by design though. Could get
assessor to take FMV and go from there, but may want to punish people for wanting to
leave.

Note 5-3
1. Interpreting the Agreement
The problem in Darr is that the partners used the capital accounts as the basis of a
distribution to a leaving partner prior to the sale of the property on dissolution for some
partners.
In other cases, the Court held a partner liable for negative balances attributable to
depreciation where that partner got all the tax benefits of depreciation.
2. The interplay of law and accounting in partnership disputes
In Darr it is likely that the partnership had accrued interest unpaid real estate taxes,
utilities, or other ongoing operating expenses that would have shown up on the year-end
balance sheet that was the basis of the buy-out price.

DEFAULT RULE: UPA (1914) 18 (a) Each partner shall be repaid his
contributions, whether by way of capital or advances to the partnership property and share
equally in the profits and surplus remaining after all liabilities, including those to partners,
are satisfied; and must contribute towards the losses, whether of capital or otherwise
sustained by the partnership according to his share in the profits.
NOTE: the difference between operating and capital losses; modern accounting makes no
distinctionlosses are losses. The reason that it matters is cases like Kessler where it
might matter. Part of the reason this matters is when we start trying to figure out what the
parties intended, its possible that the partners look at those two kinds of contributions
differently.

Kessler v. Antinora, 279 N.J. Super. 471, 653 A.2d 579 (1995)
FACTS: P and D entered into an agreement for building and selling a single-family
residence. Kessler was to provide money and Antinora was to provide general contracting.

Business Organizations Book Outline

Agreement is that when they sell the house, Kesller would get back all the money he put
in, plus his profit. Profits were to be distributed 60% to Kessler and 40% to Antinora.
ANtinora operated solely on the presumption that his work would generate a profit. The
agreement they entered into was called a Joint Venture Agreement. Joint Ventures are
typically a deal for the particular thing. Joint ventures help limit liability for outside
transactions.
o Is there a malpractice issue here? Probably.
o NJ acknowledges the default rule, but it doesnt apply because they have a
partnership agreement.
FERSHEE points to the bottom of 223Kessler agreed to provide all necessary funds to
purchase land and construct . . . etc. There was no limit on how he needed to put forth to
make it happen. People often dont think this through. This is a DANGEROUS clause.
Procedural History: lower court ruled in favor of Kessler on summary judgment. Judge
denied Antinoras cross-motion for SJ of dismissal.
HOLDING: Reversed judgment and ruled in Antinoras favor. Court says it is entirely
possible that if Kessler would have said, I want to share losses, Antinoer would have said
then I am going to need some form of compensation so I am not out of all my owrk. YOU
MUST TRACK OBLIGATIONS.
o Idea of a service (sweat partner) and equity (money) partner;
o Default rule of partnership? Losses follow partnership.
o How did the Court decide this? UPA? Other basis?
o NOTE: The Courts decision here is plausible, but not inevitable outcome.

Kovacik v. Reed

Business Organizations Book Outline

Parties orally agreed to participate in a kitchen remodeling venture for Sears Roebuck and
Company. Kovacik agreed to invest 10k in the venure and reed agreed to become the job
estimator and supervisor. Agreed to share profits on a 50-50 basis. Possible losses were
not discussed. THERE WAS NOT FORMAL AGREEMENT. Venture was unsuccessful.
Kovacik sued Reed to recove one-half the money losses he endured. Kovacik prevailed n
TC and recovered half of the losses. California Supreme Court notes that the default rule
does not apply when one party has contributed all the capital, therefore losses include
capital and service losses.
Kovacik says that Upon loss of the money the party who contributed it is not
entitled to recover any part of it from the party who contributed only services.
PLAUSIBLE OPTION, NOT DEFAULT RULE.
This is an outlier, not default rule, not the expected outcome. THIS IS A MINORITY
RULE.
Kessler rule was based on a plausible, not clearly necessary, reading of the agreement, so
the default rule did not apply.
DO NOT EXPECT THIS OUTCOMEprofits track losses as a general matter.
Plenty of cases expressly reject this case. Make sure to look for similar agreements in
essay questions.
RATIONALE: some appeal. Where one party contributes services, other contributes
capital, they both lose what they put in.
Kovacik rule not applied where: (1)The service partner (Reed) was compensated for
his work (2) The service partner (Reed) made a capital contribution, even if that
contribution was nominal.
Remember this was a summary judgment case. Were there any facts in this case?
Construed against moving party. Was that possible here?
CONCEPT OF SERVICE PARTNER AND WORK PARTNER REALLY
IMPORTANT. EXPECT TO SEE ON EXAM. BE ABLE TO ANALYZE THE
BASIS and THE MULTIPLE RULES.

Possible Rules
1) All capital losses were to be borne by the capital partner alone (Kovacik)
2) Sharing of capital losses in accordance with sharing of profits (statute)
3) Allocate capital losses as per ratio of capital contributions (can only get this rule via
agreement).
Note 5-4
1. Application of the UPA and interpretation of the agreement

Business Organizations Book Outline

UPA (1914) 40 (THIS IS IMPORTANT FOR FERSHEE and the BAR)
40(b): subject to contrary agreement, upon dissolution partnership assets should be
distributed as follows: (I) Those owing to creditors other than partners, (II) Those owing
to partners other than for capital and profits, (III) Those owing to partners in respect of
capital, and (IV) Those owing to partners in respect of profits.
40(d): "partners shall contribute, as provided by [18(a)] the amount necessary to satisfy
the liabilities [set forth in 40(b)]. . . ."
NOTE: Section 40 governs the distribution of partnership assets in the event of
dissolution.
It appears that the partnership had no liabilities falling under UPA (1914) 40(b)(I) or
(II).
Accordingly, the next set of liabilities to be satisfied were those "owing to partners in
respect of capital"; in other words, return of capital was the senior remaining claim on the
partnership's assets.
You can change this agreement with creditors by agreeing with them NOT your partner.
2. Capital losses under RUPA
RUPA provides that partners shall contribute to the partnership the excess of charges over
credits in their accounts. RUPA also provides that accounts are to be constructed by
crediting contributions and profits and debiting distributions and losses.
Unlike the UPA, RUPA doesnt make clear that losses are capital losses too. RUPA treats
capital losses the same as operating losses.
3. What should the default rule be?
It is argued that they should be designed to in some circumstances to force the party
disadvantaged by the default rule to disclose information to the other party.
4. Kessler and Kovacik approaches to the default rule
5. Loss sharing, indemnification and contribution
Allocating partnership losses among the partners also depends on the rules concerning
indemnification and contribution which correlate the partners joint and several liability to
third parties with their proportionate obligations among themselves.
Additional Class Notes
Per capita: divide losses equally; capital contribution: based on how much money you
invest.
o Per capita takes into consideration different types of contributions that can be
given to a partnership.
o Member managed and manager managed differences?
o At least make a fair default rule. LLC are fluid and flexible. Fershee likes the
member managed or manager managed provisions.
If Antinora had received straight payments, it would be more likely that an agency
relationship existed.
o However, there may be a problem with this, it is certainly reasonable, but it is not
likely that a partner would go with that.

Business Organizations Book Outline

PAT triange- principle, agent, and third party; comes about when principal manifests
consent to have an agent on its behalf; control over the agent assents to it. Helps us figure
out who is accountable to who. IF agent breaches fiduciary duty, they are liable to the
principle.
Once one agrees to be an agent, they have a duty to do what they said they were going to
do; Agent is liable if he/she breaches their fiduciary duty.
Restatement 3 of agency
Difference between owning an firm and being an agent of a firm
A firm can be a sole proprietorship; llc;
Two things we need to look for: (1) when does the agency arrive?; (2) whats the scope of
the agency?
o Sometimes the relationship shifts from partners to agent, etc
o Are you asking for favors? Is it a business favor? The scope of the relationship
matters because the principal can become account

Business Organizations Book Outline

Business Organizations Book Outline

Chapter 6: Vicarious and Limited Liability

6.01 Introduction

Unincorporated businesses differ from corporations in that the owner is responsible for
the debts and other obligations of the entity.
Historically, general partners of a partnership, subject to certain conditions, were
vicariously liable for the partnerships obligations. Corporations on the other hand,
absent a basis for piercing the corporate veil, had their exposure limited to their
investment in the corporation.

6.02 Partnership and Limited Partnership

A. General Partners Vicarious Liability for Partnership Debts
Under traditional default rules, if the partnership is liable for a debt, then the creditor
may recover from both the partnership and the individual partners. (UPA 15; RUPA
306).
Management Rationale: In closely held owner-managed firms, partners resemble
agents and share profits and are in a good position to monitor the firm and protect
against losses. This doesnt hold for all firms, especially large professional firms.
Generally, to collect from a partner, the creditor must sue and serve the partner
separate from the partnership or entity.
o Holdings L.P. v. Young (Tex. 2008)- creditor couldnt collect a judgment
rendered against a limited partnership from a general partner who had not been
sued.
Thompson v. Wayne Smith Construction Co., Inc. 640 N.E.2d 408 (Ind. App. 1994)
1986- Partnership hired Smith to build two homes in Hilton Head. Wayne Smith
(Wayne Smith Construction Co.) procured a judgment on a contract against the
partnership of Wolman Duberstein and Thompson. Smith tried to collect in SC, OH,
and IN.
South Carolina Court: After no payment, Smith sued partnership and individual
partners in SC. SC Court of Appeals affirmed judgment against partnership but
vacated judgment against individual partners. Smith didnt appeal this decision.
Ohio: 2 years later, Smith entered the judgment in Ohio Courts. Exhausted the
partnership assets in Ohio and instituted a new action against the partnership and the
partners individually for the balance of the judgment.
o Partners claim that SC court vacated the judgment and the doctrine of full faith
and credit and res judicata barred the suit. Ohio Trial Court entered a judgment
against them and while it was on appeal, Smith instituted this action in Indiana
against Kenneth E. Thompson, a general partner of the partnership.
Indiana: Trial court granted Smiths motion for summary judgment and entered
judgment against Thompson for the full amount due on the SC judgment. 6 months
after the Indiana decision, Ohio Supreme Court affirmed the judgment against the
individual partners, but held that they should split liability pro rata.
Thompson now appeals the judgment against him for the full amount.
This case raises three questions:

Business Organizations Book Outline

(1) Did the trial court err by granting summary judgment and failing to apply the
doctrines of full faith and credit and res judicata to the South Carolina judgment
regarding the liability of individual partners? (2) Did the trial court err by failing to
apply the doctrines of full faith and credit and res judicata to the Ohio judgment
regarding damages?; (3) If the court did not err, Thompson is only liable for 1/3 share
as set forth by Ohio.
o I. Partnership Assets South Carolina court merely held that a suit upon a
contract with a partnership cannot give rise to a suit against the partners in
their individual capacity on such contract. The Court went on to state that
Smith would have to prove a contract with each individual partner in his
individual capacity to recover against each one individually.
A. Individual liability:
Two ways to establish individual liability of a partner: (1) to
prove a separate contract; OR (2) prove the partnership assets
have been exhausted.
In SC, the partnership still had assets and south Carolina law
mandates that a creditor exhaust the assets of the partnership
before going after the creditors.
B. Execution:
Thompson argues that Smith barred the claim by filing two
separate claims in Ohio Court (one against partnership, then
against the partners after the assets of the partnership were
exhausted). Court says that Smith followed procedure that is
laid outexhaust partnership assets, then go after creditors.
o II. Share of Liability: Thompson argues that since the Ohio Supreme Court
split the cost, that he is only liable for 1/3 of the damages.
A. The Law of Joint liability
Ohio cites no authority when determining the pro rata share, nor
is Indiana bound by Ohio Court decisions.
Relevant authority agrees that each creditor is liable for the
whole amount.
Major difference between jointly liable and jointly and
severally liable:
o Joint liability- Each debtor is responsible for the whole
debt, but you have to sue them all. Once there all
brought in, you can still recover 100% from any one of
them. Once all the joint debtors are named in the suit,
the creditor may decide who pays up.
o Jointly and severally liable: just one party must be sued.
o Indiana holds that South Carolina was a procedural holding and the court said
that it wasnt ripe, thus there is no violation of full faith and credit.
o Indiana also says that they arent required to follow Ohio Law. South Carolina
never decided on the merits. They decide to allow the entire judgment against
Thompson because the SC judgment was a final judgment on merits. Ohio can
have its own joint liability, but they cant put them in South Carolinas final
judgment.

Business Organizations Book Outline

o It is not clear that notwithstanding the more correct and better interpretation,
that Indiana shouldnt have to follow Ohios judgment. Indiana concedes that if
South Carolina had made this judgment that they would have followed it, but
Ohio got it so wrong so they decided not to follow it.
TAKEAWAY:
o Recognize the difference between joint and several liability:
Difference is procedural, not the actual liability.
Joint liability DOES NOT turn you into a pro rata share.

Gildon v. Simon Property Group, Inc. 158 Wash. 2d 483, 145 P.3d 1196 (2006)

Facts: Plaintiff injured in a slip and fall at a mall. Sued real estate investment trust that
had interest in the property, but did not sue the titleholder, Northgate Mall Partnership.
Plaintiff is trying to hold Simon Property, partner to Northgate Mall, liable for the
injury. Simon Property manages over 200 malls and other properties, and is 99 percent
copartner of the partnership and its subsidiary.
Whether the partnership acted within the scope of the partnership business is relevant
to the question of whether the partner is entitled to indemnification and/or contribution
from the partnership and/or the partners but it is not relevant in deciding whether a
plaintiff may proceed directly and solely against the partner for his/ her wrong tortious
acts.
If Simon Property had been acting outside the scope of the partnership business, it
would have no right to indemnification, but whether indemnification is available does
not limit liability for ones own tortious conduct to third parties.
Under UPA 15 and RUPA, partners are jointly and severally liable for all partnership
obligations, without exceptions for mere or small partners.
o RUPA 306(a) all partners are liable jointly and severally for all obligations
of the partnership. Partners are permitted to modify these provisions among
each other. They are not permitted to modify joint and several liability to third
persons.
o RUPA 307: when a plaintiff sues the partnership, he must exhaust the
partnership assets first, but he doesnt have to sue the partnership as a
precondition for proceeding against the partner.
Thus, plaintiffs arent required to JOIN the partnership in an action, rather they can
sure the partner.
Here, Simon Property is the possessor of Northgate Mall. The Court of Appeals
correctly held that Simon Property itself is the actor and the possessor involved in the
allegedly tortious conduct. Thus direct recovery is permitted. Courts also have
discretion to permit the judgment against Simon Property.
The court focuses on Simon Properties ability to provide adequate relief; the
Partnerships absence in the case does not prejudice Northgate Mall or Simon
Properties; and if the action were dismissed for non-joinder, the plaintiff would have
no adequate remedy.
Holding: Court of Appeals affirmed.
Under 307(b) Simon has a valid argument. The Court reads the and

Business Organizations Book Outline

NOTE 6-1:

Exhaustion is required in cases of joint liabilityliabiltiy based on contract.

Exhaustion is not required for jointly and severally liable parties. This means the
creditors contract by default for an exhaustion requirement, although they may not opt
out by contracting for the liability of individual partners. Tort-type creditors have
not had the opportunity to contract, thus they get direct liability by default.
To achieve exhaustion, creditors may need to have the sheriff or other officer make a
return of execution showing that the assets were not found to cover the judgment.
If a partnership enters bankruptcy, creditors are exempt from exhausting the assets of
the partnership.
RUPA 306(a) may be abolishing exhaustion. Rule makes all partners jointly and
severally liable.
The Default Rules relating to partners being liable for each other have several discrete
elements:
o First, Partner As acts either have to bind the partnership or be wrongful and
attribute to the partnership.
o Second, Partner B must be vicariously liable for the obligations of the
partnership under UPA 15 or RUPA 306.
o Third, the voluntary or involuntary creditor must satisfy the exhaustion
requirements of the jurisdiction whose law governs.
o Finally, if partner B has paid more than its fair share, it may seek contribution
from Partner A.

B. Limited Partners Liability For Partnership Debts

Generally, in limited partners, creditors of the firm have no recourse against the
limited partners. This is the point of being a limited partner.
Limited Partnership statutes incorporate a remedy for third-party creditors where
limited parties have failed to honor contribution obligations or where they removed
too much money from the firm.

1. Liability for contributions

Creditors may be able to collect for debts that limited partners owe to the firm.
Partners can themselves be creditors of limited partnerships and obtain liens superior
to those of other partnership creditors subject to other law, including bankruptcy law.
LPs liability may arise under the partnership agreement as where the agreement
provides for assessments of additional contributions.
2. Liability for Distributions
RULPA and ULPA provide rights to creditors to pursue limited partners for
distributions out of the limited partnership under certain circumstances.
RULPA 607partner may not receive a distribution from a limited partnership whose
liabilities exceed the fair value of their assets.
RULPA 608- partners are liable to the limited partnership for wrongful distributions in
two separate circumstances

Business Organizations Book Outline

o (a) if a partner has received a contribution without violation of the partnership

agreement, he/she is liable to the partnership for up to a ear thereafter, but only
to the extent necessary to pay off creditors who extended credit while the
partnership was holding the partners contribution.
o (b) if a partner receives a contribution in violation of the agreement, he/she is
liable for six years for the amount of wrongful distribution.
Limited partnerships are not permitted to make distributions in violation of the
partnership agreement or if the limited partnership is insolvent in the equity or
bankruptcy sense.
A general partner that consents to such a distribution is personally liable to the limited
partnership for the amount wrongfully distributed if it breached a fiduciary duty under
408, and a partner or transferee who receives the distribution is liable for the
amount improperly paid, but if such partner or transferee knew that the distribution
was wrongful. THIS CAN ALWAYS DEPEND ON THE PARTNERSHIP
AGREEMENT.
o This doesnt eliminate limited liability. This is saying that you took out money
improperly.
o As limited partners, if you take distributions that render the partnership
insolvent, you can be liable for those debts.
o Limited Partners cant take money before creditors.

Henkels & McCoy, Inc. v. Adochio 138 F.3d 491 (3d Cir. 1997)
This case centers on the obligation of limited partners to return capital contributions
distributed to them in violation of their partnership agreement, which required that they
establish reasonably necessary reserves.
Parties involved are as follows:
o Red Hawk is the entity.
o Adochio- limited partner of red hawk
o G&A Development Corporation-general partner of Red Hawk.
st
1 Agreement
o Cedar Ridge Development Corporation and Red Hawk entered into a joint
venture agreement, the Chestnut Woods Partnership, to develop residential
homes. Red Hawk and Cedar Ridge are both General Partners of Chestnut
Woods Partnership.
Under the JV, Red Hawk was to provide funding and Cedar Ridge would provide
Land and act as managing partner and general contractor.
2nd Agreement (1988)
Red Hawk and Cedar Ridge entered into a distinct agreement to form Timber Knolls
partnership, both being general partnerships. Red Hawk gave $2.3 million and Cedar
Ridge managed and contracted. This project never commenced operations. Red Hawk
partners entered into an agreement asking for the money back.
Cedar Ridge executed promissory notes and G&A distributed the payments to
individual red hawk partners.
Cedar Ridge agreement with Henkles
Cedar Ridge entered into an agreement with Kenkles to furnish labor, materials and
equipment for the project. Agreed to pay $300,270 under contact. Henkles completed
the work, but Chestnut defaulted on payments. Henkles filed three actions:

Business Organizations Book Outline

o (1) Agaisnt Cedar Ridge and Chestnutcourt entered a judgment, but it was
never satisfied in whole or in part.
o (2) Agaisnt G&A in its capacity as General Partner of Red Hawk. Received a
judgment, but it was never satisfied.
o (3) This suit against nineteen limited partners of Red Hawk. Henkles sought
the replacement of capital distributions made by Red Hawk to the limited
partners aggregating $492,000.00 during the period that Cedar Ridge was
obligated under its contract with Henkles to pay. Henkles alleged that the
capital distributions were made in violation of Red Hawk Limited Partnership
agreement.
Court rejects that argument that Henkles was not a creditor when the contributions
were made. According to statute, when wrongful payments are made, you have to put
the money back and are liable for up to 6 years. The Courts say the LPs are trying to
add 606(a) and 606(b) together. Here, the limited partnership agreement was
supposed to keep cash for obligations, etc.
Court rejects a remoteness defense. The LPs say that they are too far removed to be
found liable. Cedar Ridge and Chestnut Woods relationship-partners and contractors
by virtue of being contractors, the relationship changes to one of undisclosed
principal relationship. Thus Cedar Ridge can be liable directly and as an agent.
o Cedar Ridge was liable on the sewer contract, but Chestnut Woods was also
liable as the partnership principal, thus CW as a general partnership is
accountable for all the debts. Cant hold the limited partners liable for the
entire contribution, but you can hold them accountable to contribute back that
which was wrongly distributed.
Liability for General Partners: All partners are jointly liable for the debts and
obligations of the partnership. Court doesnt buy any arguments against this.
Do the 1989 contributions violate the partnership agreement?
o 12(a)sets up a hierarchy of payments to be disbursed. 12(a) also says that
partnership cant hoard cash. Limited Partnership/Pass through LLCpaying
the income taxes either waythus partnerships cant sit on cash, they must
pay out. However, they must keep money in the account to cover the reserves
covered in clause 9(b).
o 9(b) gives the general partner the authority to create a reserve to pay creditors.
Problem we see here is that in accounting, reserves mean something
specific. This would be deemed as a general matter to be off the
balance sheet. Here, they must likely mean a reservation of cash.
The Court basically says that despite what the limited partners claim, Henkles was a
creditor of Red Hawk. The Limited Partners argue that at the time of the distributions,
Henkles wasnt a creditor, but the court says that since the partnership agreement
between Cedar Ridge and Henkles was signed before the distributions were made,
Henkles was in fact a creditor, thus the Limited Partners should not have taken the
contributions.
Court ordered the partners to return the improper distributions to Red Hawk.
Notice, this is not disregarding limited liability. When you say to a limited partner,
you owe money back the partner will often claim that the limited liability is gone.
Distinction here is that it is not clear based on the partnership agreement. Be able to
make this argument on an exam.

Business Organizations Book Outline

C. Indemnification and Contribution

1. Indemnification
Settling up between partners in an ongoing partnership. Reconciling what is owed. i.e. if you
owe $1,000 to the partnership and a partner owes you money, you pay and get paid, thus
youre settled.
UPA 18(b) and RUPA 401(c) allow partners to be indemnified by the partnership for
payments made and liabilities incurred in the partnership business. Thus while a single
partner may be liable for all the debts to third partners, indemnification provides a way
to adjst loss sharing among the partners. Scope is unclear.
The partners act must be at least apparently authorized or within the scope of the
partnership business to trigger a partnership liability under the rules. However, the
partners right to indemnification may be either broader or narrower than the
partnership liability.
The rules are questionable. One possible way is to treat their indemnification rights as
related to their fiduciary duties.
Mary and Carl agree that Carl is going to get some contracts with Motorola. Carl spends
$4,000.00 on dinner. Mary thinks Carl made a mistake, but he wants to be reimbursed for the
personal expense. Is there any doubt that Carl had the authority to do this? If he would have
billed the dinner to the partnership, would he have had the authority to do this? He may have
used poor judgment, but its not problematic in this setting. How is carl getting the money
back considered settling up? IndemnificationMary has to write him a check. Mary
doesnt think Carl should be reimbursed under the UPA 18.
Partner can only be indemnified for payments made and persona liabilities incurred in
the ordinary and proper course of business.
Does carl deserve to be paid?
Did he overstep actual authority? Probably; Did he violate his fiduciary obligations?
Probably not breaching the loyalty obligation. Generally going to respect this unless
there is something egregious in the circumstances.
Carl deserves to be paid.
2. Contribution
Deals with a partnership in dissolution. As for contribution, if there are no assets left in
partnership, there are still unpaid creditors. Partners contributory losses in the same as their
profit proportions.
Assume Mary, Ben, and Carl have the partnership, it goes bust, but there are still
creditors, and Carl is insolvent. Statutes say that remaining solvent partners have to
cover the insolvent partners obligations. Settling Carls debts, you use the ratio
between the remaining partners to determine this liability.
Indemnification is like other partnership payments it reduces the firm profits. In
dissolution the partnerships liability for indemnification, like any other liability, is
paid out of the assets. If there arent enough assets to pay, partners must contribute to
make up the resulting defecit.

Business Organizations Book Outline

Indemnification is a partnership obligation, while individual partners pay

contribution.
Note, if a creditor has already exhausted the assets, it may be worthless for a partner to
pursue an indemnification claim against the partnership, however, the partner may be
able to seek contribution from the individual partners.
3. Drafting the Partnership Agreement
Agreements should cover indemnification and contribution provisions.
Indemnification provision should cover liability ot third parties and liability to the
partnership for breach of fiduciary duty.

6.03 Limited Liability in LLCs

A. The Default Rule

Default rule is that generally, partners are not liable solely by reason of their
membership in an LLC. Contrast with what we see in the default rules for
partnerships.
NOTE 6-3
1. Members and Managers wrongful acts
Default rule does not exclude liability for wrongful acts by individual members or
managers.
2. Managers liability:
In issues with torts, LLCs do not protect members or managers and agency law is
applied normally. An agent is still always responsible for its own torts, even if the
principal is also liable under respondent superior. If managers engage in negligent
conduct, the liability shield of an LLC is of no protection.
Countryman case: Concept of Double Circle as an LLC providing propane, Keyota has
99% equity in Double Circle and Farmdale owns the rest. Board of directors are the
same, etc. Keyota and Double circle have all this overlap, but theyre still separate.
Explosion kills countrymen and they sue both entities. Double Circle is responsible for
the tort/negligence for its agent Keyota. Is Keyota as a member/manager liable for the
debts of Double Circile? Answer here is no. Keyota cant be liable just because Dave,
the owner, is also the manager of Double Circle. However, Keyota is liable for
reasons unrelated to LLC law. Even as an agent for a disclosed principle, you are
always responsible for your own torts, even if the principal is also liable.
3. Opting out of limited liability:
Members can agree to be held liable for all or some of the partners debts. This allows
some members broadly erase the liability limitation without having to contract with
individual creditors.

B. Veil Piercing

Piercing the veil of LLCs to impose liability on members that have complied with
statutory formalities is a tricky question.
Corporate veil piercing is based on equiptable and common sense grounds, and they
should apply here:
o Misrepresentation of capitalization or of owners responsibility for debts;
o Deliberate undercapitalization in the form of excessive dividends; or

Business Organizations Book Outline

o Comingling of firms and the owners assets.

Most cases apply corporate standards. Some statutes confirm this method.
One key difference between the two contexts is that an LLC is generally less formal
than corporations and courts take this into consideration.
o Horton Inc. New Jersey v. Dynaster Development LLC- declined to pierce the
veil where the owners lack of attention to detail was characteristic of a smallbusiness owners, and operating several small business out of one space was a
reasonable decision.
o Thus greater informality in the LLC, more tolerance for owner domination and
control.
When facts are egregious, courts will pierce the veil in the LLC even while
acknowledging the greater formality likely to be observed.
Minnesota Law expressly says as to LLCs you will use the corporate law at to
piercing the veil
We dont pierce the veil just because someone isnt getting paid. There has to be more
than a lack of payment or lack of available credit, otherwise limited liability wouldnt
mean anything.
ULLCA- 303 (b)beauty of an LLC is you get to be more free form, and it wont
be held against you.
ULLC v. Minnesota: ULLCA seems to say something else must be done to pierce
the veil. Minnesota Law says that you should follow corporation law. This is
contradictory. The argument is not you cant pierce the veil. Means you must
determine how to pierce the veil under the LLC Act. LLCs and Corps are very
different. Notice the state in which youre operating might require an LLC to do more
(Minnesota).
Two Theories:
o (1) Under capitalization- people get together, start a company, and do not put
enough money in to legitimately start the entity. The sense of capitalization
should be looked at from the outset. Dont look at the competence of the
partners to run a business, look at what they put in at the beginning.
o (2) Alter ego- where the corporation is so controlled, that it is the alter ego of a
stock holder. The reason this becomes problematic is because corporations
have very clear requirements on their procedures, LLCs are more lax and laid
back. LLCs are favored because they lack those formalities and still extend
limited liability. LLC LAW CAN BE DANGEROUS HERE.
The whole concept of piercing the corporate veil is unpredictable. What rises to the
law of injustice seems to come down to what the court feels right.

Kaycee Land and Livestock v. Flahive 46 P.3d 232 (Wyo. 2002)

Certified Question: In absence of fraud, can the limited liability veil be pierced in the
same manner as a corporation? The Court affirms this question.
There was no allegation of fraud in this case. Several contracts were executed between
oil and gas companies.
Wyoming LLC Act and ULLCA difference: ULLCA says solely by reason of his own
acts or conduct. Wyoming LLC act seems to be you cant hold me liable for anything.
No piercing the veil for debts. Why didnt the courts like this?

Business Organizations Book Outline

The Courts determine that LLC veil piercing should follow the realm of corporate veil
piercing since the corporate veil piercing case law is already established.
Historically, the concept of piercing the corporate veil was created as a remedy for
situations where corporations have not been operated as separate entities as
contemplated by statute and, therefore, are not entitled to be treated as such.
The determination of whether the doctrine applies centers on whether there is an
element of injustice, fundamental unfairness, or inequity.
Holding: No reason exists in law or in equity for treating LLCs different than
Corporations when considering whether to disregard the legal entity.

TAKEAWAY: He will give a statute and fact pattern then say this is the states
law.
6.04 Creditors Contracts with Owners
Creditors wanting to avoid the limited liability shield ahead of time should simply
request that the individual members agree explicitly to be liable for the LLCs
obligations by way of a guarantee.
Even in general partnership, creditors can obtain guarantees as a way of avoiding
exhaustion requirements.
Regional Federal Savings Bank v. Margols 835 F. Supp. 354 (E.D. Mich. 1993)
Plaintiffs want to hold the defendants liable for the entire amount on a loan, the
defendants won on summary judgment, and this court affirms the lower courts ruling.
Defendants filed an application for a loan. The loan agreements said that the
defendants were personally liable for repayment of 30% of the loan. The parties
executed a note, security agreement, and a mortgage.
Despite the counter and cross claims, defendant Goldbaum filed the SJ motion.
The court examines the contract and finds that the terms are unambiguous, but further
states that when a contract is unambiguous; they can examine extrinsic evidence that
demonstrate latent ambiguity. Defendants present several pieces of evidence to show
that they assumed they were signing an agreement that held them personally liable for
30% of the note.
The Court finds that the defendants evidence shows that the contract was ambiguous.
The Court finds that it was the clear intent of the parties to the loan that the members
of the partnership would only be personally liable for the first thirty percent, or
$126,000, of the note. Court helds that plaintiff will have to recover the rest from
assets of the partnership, including the property.
Commons West Office Condos, Ltd. V. Resolution Trust Corp 5. F.3d 125 (5th Cir. 1993)
Weilbacher was found liable for 100% of outstanding indebtedness on a promissory
note he executed as general partner, on behalf of Commons West Office Condos.
Weilbacher appeals claiming that he executed a guaranty agreement, which limited his
liability to 25% of the indebtness. The judgment of the lower court is affirmed.
When Weilbacher entered into the loans, he executed a guaranty agreement in his
individual capacity, guaranteeing 25% of the principal of the note, as well as 100% of
the interest, expenses, and costs associated.

Business Organizations Book Outline

The Court finds that although he guaranteed himself personally for 25%, he didnt
shield against his obligation to the firm as the general partnerwhich makes him
liable for the firms debts.

NOTE 6-5
In analyzing cases dealing with liability limitations and guarantees, it is important to
keep in mind that there is a technical difference between a partner guarantee, which
allows the creditor to pursue the partner directly without exhausting remedies against
the partners, and a partners statutory vicarious liability that may entail an exhaustion
requirement.
Partner signing credit agreement as agent for the partnership: as a general rule, an
agent is not liable on a contract the agent executes for a disclosed principle.
Agreements to be personally liable for LLC debts and obligations: LLC members
ought to face the same problems of inadvertent vicarious liability as partners who
execute guarantees

Business Organizations Book Outline

Chapter 7: Ownership and Transfer

7.01: Introduction
Ownership of property in corporations is straightforward since investors own their share of
stock and have no claim to the corporations assets; stock is freely transferable and no rights
transfer with it aside from the ownership of the share.
Partnership is more difficult because partners have dual interests economic and management
rights. The problem becomes more complex with limited partnerships and LLCs.
7.02: Property Rights in Partnership
Under UPA 24 partners have 3 types of property rights
(1) in specific partnership property (2) in the partnership as a whole; and (3) in management
A. Partners Interest in Specific Partnership Property
What is partnership property?

Any asset acquired in the name of the partnership is partnership property can
be done one of two ways: (1) transfer directly to the partnership in its own
name or (2) transfer to one or more partners acting in their capacity as partners
AND the name of the partnership appears on the transfer document (if not the
document must otherwise indicate that the buyer was acting in his capacity as a
partner).

Property purchased with partnership funds is presumed to be partnership

property.

Partners rights to partnership property is related to their rights in the firm; they cant take
more than their agreed share or unilaterally deal with partnership property as if their own.
Essentially partnership property is held in tenancy in partnership all have equal rights to
possess the property for partnership purposes but NO rights to possess for personal purposes;
partners must agree on what to do with the property. You cannot use partnership property to
take on personal debts.
UPA 25 partners can only use partnership property on behalf of the firm; they have no
individual interest that they can sell OR that is available to the partners creditors or heirs.
(i.e., if youre a partner and you go bankrupt partnership property is not part of the bankruptcy
estate)

Under the UPA rights to partnership property are extremely tenuous really a fiction
to maintain the aggregate nature of the partnership
Under the RUPA there is not even the fiction of owning partnership property - 201
defines the partnership as an entity wholly separate from the partners.

Business Organizations Book Outline

If the partnership is dissolved and liquidated, equity is paid out and the partners split the
specific partnership property.
B. Partners Interest in the Partnership
Although partners dont really own specific partnership property they own a financial interest
in the partnership entity his share of the profits and surplus
This interest (sharing in profits) is fully transferable to assignees, creditors or heirs BUT
whomever the interest is transferred to holds only financial interests; they do not hold
management rights a partner would have unless all agree to admit the assignee as a partner.
(Note: the assignee does have the independent right to have an at will partnership judicially
dissolved)
C. Partners Interest in Management
The default rule is that all partners have equal right to management but you can contract
around it.
This property right cant be transferred without the consent of all of the partners since
partners normally would want to be able to choose their partners since they will be liable for
debts created by them.
7.03: Transfer of Ownership Interests
This section deals with the extent to which partners are able to voluntarily transfer their
property rights; the important issue in these cases is distinguishing what kind of property right
they are attempting to transfer.
A. Partnerships
Sunshine Cellular v. Vanguard Cellular Systems, Inc.
Facts: Kerrigan, Estess, and Belendiuk (KEB) are all partners in Sunshine Cellular. B
decides to sell his 15% interest in the partnership for $2.6 million subject to K&Es
right of first refusal to NPCT (Vanguard subsidiary). K&E didnt exercise their right of
refusal so NPCT says they want management rights too; K&E say we didnt agree to
admit you as a partner the only right B had to sell was his right to profits, not
management.
KBE Partnership Agreement:
Paragraph 16: When a partner wants to transfer his ownership rights he
must first give the other partners a right of first refusal;
Paragraph 1: Each party shall initially own the percentage state in Exhibit A,
in terms of profits, losses, and voting.
Silent as to votes to admit new partners
Issue: Did Sunshines partners make an agreement to override the default rule
that a partner may convey his interest in the partnership without first

Business Organizations Book Outline

consulting his other partners but must obtain the unanimous vote of the
partners to transfer management rights?
Holding: Summary judgment for Sunshine is denied because paragraph 16 of
the agreement is ambiguous as to the rights partners have to transfer without
consent.
Reasoning: NPCT(Vanguard after the first suit is dropped) argues that
paragraph 16 allows free transfer of management rights if partners have not
exercised their right of first refusal; Sunshine says we had to have expressly
allowed that and we didnt. The court says the idea that the partnership
impliedly agreed to override default rules has to be rejected there are too
many consequences of admitting a new partner BUT it doesnt have to be
express either just has to clearly authorize the action. The court then looks to
whether the agreement authorized it.
Court then looks at paragraphs 1 and 16 Vanguard argues that the definition
of ownership rights in paragraph 1 means the profits, losses, and voting in
paragraph 16 they argue that is a bundle deal if the partners dont exercise
the right of refusal. The court is hesitant to accept this definition since it
contradicts Marylands UPA that says the different rights are distinct, not a
bundle. But since its at the summary judgment stage the court says that the
lower court needs to examine it because Vanguard may have a viable argument
that the agreement authorized the transfer of both financial and management
rights.
NOTE 7-1
Partners may want to prevent transfer of partners financial rights if 50% of the
capital and profits interest is sold or exchanged within 12 months, the partnership is
terminated for tax purposes and can cause a constructive liquidation leading to other
tax consequences.
An assignee of financial rights isnt technically a partner so they lack a partners
fiduciary rights since no contractual relationship between the assignee and the
remaining partners; the assignee must rely on his contract with the assigning partner
who may act on their behalf in decision-making. Since creditors and heirs dont have
this relationship courts may be more lenient and impose duties not to hurt or to inform.
B. Limited Partnerships
In limited partnerships the partners have both management and financial rights but still cannot
freely transfer management rights. Limited partners, although more passive than general
partners, often have voting rights on significant issues this section examines the transfer of
those rights in limited partnerships.
Northeast Communications of Wisconsin, Inc. v. CenturyTel, Inc.
Facts: Partnership formed as a joint venture among 5 firms for cell communications
market. (KDM Cell, Inc., owned by 4 of the 5 acted as managing partner) Universal
cellular subsidiary participated in this partnership and also has a parent, CenturyTel

Business Organizations Book Outline

Wireless. CenturyTel was acquired by Alltell. Northeast thought that this triggered the
right of first refusal under Section 11.1. Universal says no, that only comes into play
when a member sells their stake and that didnt happen here. Then Northeast argues
that since 11.5 gave the other 2 firms an option to buy if the 3 firms in section 11.5
refused, they had an additional option aside from 11.1. Northeast also argues that the
change in ownership structure makes Universal a stranger to the partnership and
changes who controls the partnership interest.
The Agreement:
Section 11.1: Before any member may sell its stake, any of the other members
may step in to acquire that interest.
Section 11.3: Northeast may sell to Wayside or vice versa without conferring a
right of first refusal on the other 3 firms.
Section 11.5: Casco, Universal and Lakefield (other 3 firms) may transfer to
their respective affiliates without consent any other disposition of ownership, and the
3 in this category get a right of first refusal this applies only to sales by Casco,
Universal, or Lakefield, or their affiliates to each other or their affiliates.
Issue: Does a corporate merger involving the parent of a member of a limited
partnership activate a right of first refusal?
Holding: No.
Reasoning: The court says 11.5 doesnt apply because it is only invoked when a
member sells to Casco, Universal and Lakefield that didnt happen either so no
provision gives a right of refusal when there is a corporate merger. The court sees 11.3
and 11.5 as confining the 11.1 provision, not expanding it to give more rights.
Note 7-2
There was evidence that the firms were small, family owned businesses who drafted the
agreement to make sure they would be doing business with other small companies and made
the provisions to make sure they wouldnt be doing business with large companies that would
take over, but here the court ignored the intent of the parties and looked at the language of the
agreement.
C. LLCs
LLC statutes, like partnership statutes dont provide for free transferability of management
rights by default only financial rights. Usually has to be unanimous but some statutes allow
a majority or a majority in interest to allow management rights transfer. (majority in interest
can be confusing because some statutes provide for voting based on member contributions for
example)
Due to limited liability, the transfer of management rights in an LLC isnt as big of a deal as
in a partnership.
Achaian, Inc. v. Leemon Family LLC
Facts: Omniglow sells glowsticks; when it was founded it had a sole member and its
parent corp. In a spin-off, however, Parent corp sold Omniglow to 3 business entities:
(1) 50% to Leemon Family LLC (2) 30% owned by non-party Holland Trust and (3)

Business Organizations Book Outline

20% owned by plaintiff Achaian, Inc. (wholly owned by William Heriot). For 2 years
Holland and Leemon managed with Achaian taking a passive role but soon after
Leemon allegedly took sole control over Holland and Achaians objections (contrary
to LLC agreement). Holland agrees to sell his 30% to Achaian to challenge Leemon.
Achaian brings suit to dissolve the LLC because Achain and Leemon are deadlocked
on everything cant carry on w/ LLC agreement. Leemon says Achaian only got the
economic interest; never had Leemons permission to be re-admitted as a member
with the additional 30%.
Issue: May one member of an LLC assign its entire membership interest include that
interests voting rights, to another existing member if the LLC agreement requires
consent of all members upon admission of a new member?
Holding: Yes.
Reasoning: The LLC agreement defines a members interest as the entire ownership
interest of the Member in Omniglow. The provisions do not require a member to be
readmitted when acquiring additional interest just that a new member be ratified by
the members.
Note 7-3
In an LLC where the default statute requires a unanimous vote to allow transfer of
management rights, members may want to reduce by contractual agreement to a majority or a
majority in interest to protect against excessive decision-making costs
If there had been a right of first refusal, Leemon could have blocked the transfer; rights of
first refusal are a good control mechanism for admitting new members when drafting LLC
agreements.
7.04: Creditor and Third Party Rights
A. Partnerships
1. Creditors
All creditors/heirs are able to reach in a partnership are the partners financial interests
in profits or distributions do this by applying for a charging order (usually
available only to a judgment creditor but courts have granted these orders to others,
including spouses seeking alimony or child support.
A personal creditor can go after the partners interest in the partnership, but not
partnership property
If a personal creditor and a partnership creditor both exist and go after the partners
interest the partnership creditor gets paid first.
Hellman v. Anderson
Facts: Anderson, individually, owes money to Hellman and Eureka. Anderson is
partners with Tallstrom in RMI. Anderson owns 80% of RMI, while Tallstrom owns
the remainder and is the managing partner. When Anderson doesnt pay Hellman,
Hellman gets a charging order to convey profits that would be due to Anderson to

Business Organizations Book Outline

Hellman. Hellman still hadnt received the money and filed a motion to foreclose (take
possession and sell assets) on Andersons partnership interest in RMI since the
charging order (just taking profits) wasnt satisfying the judgment. Lower court
ordered a public sale of the interest of Anderson in RMI.
Issue: Is foreclosure an appropriate option to satisfy a judgment when the other
partners dont consent to the sale?
Holding: Yes. So long as the foreclosure does not unduly interfere with the
partnership business.
Reasoning: Court says that statutorily, foreclosure is authorized; you have to first
apply for a charging order but foreclosure is the next step where the creditor has
shown it was unable to obtain satisfaction of the debt under the charging order AND
where the remaining partner has consented to the sale (according to case law). The
court says that this consent is not an invariable rule if the legislature wants to change
it to a requirement they should but as long as it doesnt unduly interfere with the
business of the partnership (policy concern) foreclosure is okay. Court says it wouldnt
always interfere with the partnership because the statutory scheme of partnerships
limits the interest subject to foreclosure (no management rights or rights in specific
property) however, dissolution is always an option so it may interfere in most cases.
Note 7-4
Creditors may request charging orders to get the profits of a debtor in a partnership, but the
debtor partner continues being a partner in all other respects; no management rights and is not
owed fiduciary duties. The creditor just has to wait for the non-debtor partners to decide to
make contributions.
A foreclosing creditor may be able to force some distributions by exercising an assignees
power to seek a judicial dissolution; because of this some courts have been more restrictive in
allowing foreclosure.
2. Rights of Divorced Spouse
Spousal rights in divorce are similar to creditors since money that would have been awarded
in divorce may be tied up in partnership assets, it is a similar situation the divorced spouse
may seek a charging order, foreclosure, then dissolution if necessary but is likely restricted to
what the partner is entitled to receive per the partnership agreement.
B. Limited Partnerships
Charging orders may be made against all partners; but the RULPA provision is similar not
identical to the general partnership provisions so some issues of linkage are created.
Baybank v. Catamount Construction
Facts: Eugene and John Connor (the Connors) are limited partners in East Street
Associates. They had a judgment rendered against them as guarantors of a promissory
note made by Catamount Construction Baybank is the judgment creditor. Baybank
was granted a charging order to the Connors interests in East Street (court allowed the

Business Organizations Book Outline

provision that East Street be dissolved if the judgment wasnt satisfied in 14 days).
The defendant challenged the courts authority to grant this remedy.
Issue: Did the trial court have authority to charge the Connors interests to Baybank
and did the trial court have authority to grant dissolution as a remedy to a creditor of a
limited partner?
Holding: The trial court had authority to charge the Connors interest to Baybank, but
not to grant dissolution to the creditor of a limited partner.
Reasoning: Baybank contends that the charging order alone wouldnt even satisfy the
accruing interest on the judgment debt, so dissolution is necessary. Court says have to
do foreclosure, then dissolution if necessary (Baybank wanted the proceeds of a
particular piece of property owned by the partnership; think it was fraudulently
conveyed) The court wants to make it as hard as possible for individual creditors to get
to partnership property so you have to go through all the steps first. Court says you
have ways to get your money, if you think the Connors fraudulently conveyed the
property to shield it from creditors, your recourse is in a different area of law, not
exceptions to partnership statutes.
C. LLCs
LLC statutes provide for charging orders similar to partnerships and limited partnerships but
is silent on whether the interest can be foreclosed on as to the rights of a creditor-assignee
dont know whether to apply general partnership law, limited partnership, or some other law.
*ULLC and RULLC allow for foreclosure but Delaware LLC statutes, and several
other states do not.
In a single member LLC, a court in Florida held that a charging order statute was not the
exclusive means by which a creditor could get access to a judgment debtors entire interest,
including management rights. (Olmstead) The Florida legislature responded to clarify the
distinction between multi-member and single member LLCs -- statute providing that in multimember LLCs a charging order is the sole remedy but in single member LLCs if a charging
order is insufficient, foreclosure is permitted and the creditor obtains all membership rights.
Note 7-7
A court may use reverse veil-piercing to allow creditors to access funds that debtors have
basically protected in an LLC. For example, a court allowed a creditor to get to money when
an LLC was owned 97% by the debtor who had contributed hundreds of thousands of dollars,
and the remaining 3% was owned by her husband and daughters who had given $10 mom
ran everything, others had no say so. May have gone differently if it hadnt been her family
but the court employs this to prevent injustice.

Business Organizations Book Outline

Chapter 8: Fiduciary Duties

8.01: Owners Fiduciary Relationship in Unincorporated Business Entities
Courts imply fiduciary duties where the fiduciary (trustee, agent, partner, corporate
director) has the power to exercise discretion on behalf of a beneficiary (principal, co-partner,
shareholder). Courts find fiduciary duties where one persons discretion should be controlled
because they have some measure of say over the other persons interest assurance that the
other will manage it in the owners interest.
Courts apply a fiduciary duty on a case by case basis many different types of relationships
make it difficult.
**Meinhard v. Salmon**
Facts: Gerry leased to Salmon the Hotel Bristol for a term of 20 years to change the
hotel building for use as shops and offices at a cost of $200,000. Salmon forms a
partnership with Meinhard to manage the hotel Meinhard was to pay Salmon of
the moneys required to change/operate the property and Salmon was to pay Meinhard
40% of profits for first 5 years, then 50% thereafter. The parties bore losses equally,
but Salmon had sole power to manage, lease, underlet and operate the building. In
early years it operated at a loss but then it picked up and the hotel was very profitable.
When the lease came to an end it was going to revert back to Gerry he wanted to
long-term lease it again to someone who would destroy the buildings and rebuild in
their place. Unable to find any takers so he approaches Salmon and leased the Bristol
Hotel property to Salmon/his company for 20 years with the option to extend to a max
of 80 years (buildings must be torn down after 7 years and new ones constructed at a
specific cost) Salmon kept the negotiations to himself didnt even inform Meinhard
about the bare existence of the project. Once Meinhard finds out about it he demands
that the lease be held as an asset of their joint venture. His demand was refused and
Meinhard sued. The lower court gave Meinhard 25% interest; on appeal the judgment
was enlarged to give him 50% (with increased obligations) Salmon appealed.
Issue: Whether a managing co-venturer owes a fiduciary duty to inform a silent
partner about future opportunities related to the co-venture.
Holding: Yes. Salmon owed a duty to Meinhard to disclose the lease renewal so
Meinhard might have had the opportunity to be part of it or to compete for it.
Reasoning: Joint venturers, like co-partners, owe a duty of loyalty while the
enterprise continues so Salmon owed a duty of loyalty to Meinhard until the end of
their 20 year agreement. Cardozo says that the duty is much higher than the conduct of
a marketplace not honesty alone, but the punctilio of an honor the most sensitive is
the standard of behavior. (During co-venture you owe the highest level of duty as you
would a partnership).
The court has an issue with the fact that Salmon didnt disclose the opportunity to
Meinhard, and on top of that since Meinhard was a silent partner, Gerry could not
have even known about Meinhard (had Gerry known, the court presumes he would

Business Organizations Book Outline

have offered the deal to the both of them). Had Salmon disclosed the opportunity to
Meinhard, he would have had the opportunity to compete if they didnt want to
attempt it together, but Salmon came about the opportunity by virtue of his agency and
as managing co-adventurer should have disclosed the opportunity because he had
exclusive powers of direction, particularly because of its relevance to their venture.
Had it been a faraway building or an unrelated endeavor it likely wouldnt have
violated his fiduciary duty. No reason to assume he acted in bad faith, probably just
thought their co-venture was over so he could begin anew on his own but one partner
cannot renew a lease for his own use even if its term begins at the expiration of the
partnership.
Andrews Dissent: There was no general partnership it was a joint venture for a
limited object to end at a fixed time. The question is whether actual fraud, dishonesty
or unfairness exists. The new lease covered additional property, had new terms and
conditions, with possible longer term. If this would have been a partnership then
Meinhard is entitled to his share here Meinhards interest was only in the original
lease; not in its renewal (Andrews goes on to say its not a renewal anyways). Absent
fraud or deceit, failure to disclose is not enough in the context of co-venturers.
Note 8-1
Meinhard v. Salmon is one of the most cited cases, but many courts have spottily applied its
precedent, believing that Cardozos extremist language (renouncing the thought of self) about
the standard of duty was exaggerated to make up for poor facts. But some courts do, so its
difficult to predict how a court would go if they dont follow precedential case law.
Doctrine of Organizational Opportunities to what extent to business opportunities of
which a fiduciary learns belong to the firm as opposed to the individual? Restatement of
Agency says absent an agreement, an agent is to act solely for the benefit of the principal in
all matters connected with its agency.
Much of the task in determining the extent of fiduciary duties must be left to the parties
agreements (since we dont know what courts will do when theres no express guidance) so
drafting these provisions is really important.
Considerations from Meinhard there are distinctions of degree 1. Joint venturers v.
General partners 2. During the partnership v. at its end 3. Geographic location of the new
venture 4. Status of Salmon as the partner with the information (active v. passive).
You cant eliminate the duty but you may identify specific categories of activities that dont
violate the duty of loyalty unless theyre manifestly unreasonable.
Statutorily Is Meinhard the right default? If partners are able to withhold information there
is incentive to drive the other out; as they take precautions to exclude the other, the firm
declines in value a rule that vests the firm with a property right to the information and
imposes a duty to disclose is probably the best/most efficient default.
The UPA/RUPA arent as strict as Cardozo on the no selfishness front obviously cant do
self-dealing, but since partners are both principals and agents some flexibility is necessary.

Business Organizations Book Outline

8.02: Specific Duties
**DUTIES ARE IMPORTANT: (A) Disclosure; (B) Loyalty; (C) Care; (D) Good Faith
Basic idea: refrain from self-dealing; dont appropriate the firms assets for yourself at the
detriment of others; dont compete with the LLC; things that trigger loyalty are pretty
standard, how the courts will determine the duty is different.
A. Disclosure
Walter v. Holiday Inns, Inc.
Facts: Walters created 2 corps. (L&M Walter Enterprises and Bayfield Enterprises,
Inc.) The two corps formed a general partnership known as Marina Associates. Walters
sold Bayfield Enterprises to Holiday Inn, forming a 50/50 partnership to develop a
casino. The two agreed to make equal contributions, but if one partner was unable to
meet its share, the other could pick up the slack but would result in the non-paying
partners dilution of interest in the casino. Holiday presented Walter with projections of
a worst case scenario for the casino that wasnt doing so well at the beginning, and
says he relied on this information when he declined to pay his contributions, which
resulted in a dilution of his interest. The partners approved an agreement that allowed
Walters access to all financial statements and reports. The financial situation led
Walters to want to sell his interest, and he and Holiday began negotiating a buyout.
Sometime after the buyout, the casino became profitable and Walters sued alleging
that Holiday had not provided them with the information they needed to negotiate the
buyout, and that they had designed the dilution of interest strategy to force buyout
terms unfavorable to Walters.
Issue: Did Holiday breach their fiduciary duty to Walter by not disclosing financial
and cash flow projections, audit reviews, and designing a dilution of interest scheme?
Holding: No. Holiday and Walter had equal access to the partnership records and
Walter had the raw data and opportunity to make the discoveries for himself.
Reasoning: The court begins by noting that whether or not Holiday owed a fiduciary
duty to Walters and it was or wasnt breached, it doesnt matter if the conduct was not
material to Walters decision to sell their partnership interest. Sophistication and the
degree of access to partnership records are key factors, particularly where the duty to
disclose is at issue. Since Walters conceded that they were both sophisticated
investors, the court only looks at Walters access to the records. Walters argued that
Holiday was the managing partner and owed a higher duty because they had exclusive
control over the casinos financial information. The court rejected this argument and
found that the plaintiffs had equal access to the financial records the court then goes
on to examine whether the disclosures/omissions were material to Walters decision to
sell he alleges he wasnt given a report that made financial projections (court says
true, but you had the same raw data); cash flow projections (court says its
unreasonable to require a partner to disclose every internal projection particularly
where the other partner has equal access to partnership records).
Appletree Square I Limited Partnership v. Investmark, Inc.

Business Organizations Book Outline

Facts: Appletree was formed to purchase and operate an office building. The suit
centers around 2 transactions 1. The buildings sale in 1981 and 2. Acquisition by
sale of a 25% interest in Appletree. An affiliate of the purchasers, CRI, represented
them in both transactions. CRI wrote a letter to the sellers requesting any information
you havent sent that would be material to my clients investment in this development.
CRI was told to inspect the building and records because the sellers couldnt possibly
know what would be material to the purchasers decision. The purchasers later found
out that the steel in the building was coated w/ asbestos costing $10 million to abate.
The purchasers then sued the sellers for failing to disclose the presence and danger of
the asbestos.
Issue: Did the sellers have a fiduciary duty to disclose to the purchasers the presence
and dangers of asbestos?
Holding: Yes. The appellate court reversed the trial courts grant of summary
judgment since a factual issue of actual breach existed.
Reasoning: Parties in a fiduciary relationship (here theyre partners in a LP) must
disclose material facts to each other and silence may constitute fraud. Under common
law, the sellers had a duty to disclose the asbestos if they knew about it. The trial court
interpreted the ULPA (general partners must disclose to limited partners upon
reasonable demand) as overriding the common law rule but the appellate court says no
it doesnt negate the broad duty to disclose. The trial court also found that the parties
had contracted to narrow the duty to disclose, but the appellate court says narrowing it
to require disclosure only when asked invites fraud because partners wouldnt know
what to ask for. As to the sellers response that the purchasers inspect the building, the
appellate court says that the purchasers may have justifiably relied on the sellers
failure to disclose the sellers built the building and had superior knowledge about the
asbestos while the purchasers were just financing and marketing so they likely
expected the sellers to tell them if something as big as asbestos was present. The lower
court had granted summary judgment; the appellate court says there is at minimum a
factual question as to whether the duty was breached.
Note 8-2
RUPA requires certain information to be disclosed without demand, and other information
only on demand.
The disclosure duty between partners, as in other contexts, is limited by concepts of
materiality (the information would be important to a reasonable person) and scienter
(defendant knew or should have known of the misrepresentation or omission).
What about before the partnership forms? there is an argument that there should be a preformation duty to disclose, but many have found that to be inconsistent with the lack of a
fiduciary relationship at the time; although no special partnership duty to disclose may exist,
parties may be under a good faith obligation to disclose (failure to do so may be active
concealment and actionable misrepresentation).
During winding up? still have the fiduciary duties you had during the partnership
B. Loyalty

Business Organizations Book Outline

The duty of loyalty is articulated as the duty to refrain from self-dealing in partnership
transactions, selfish use of partnership property, competition with the partnership including
conflicts of interest, and use of partnership opportunities (See Labovitz v. Dolan for the scope
of this duty in limited partnerships)
Note 8-3
The duty of loyalty begins at formation of the partnership, but may extend to pre-formation
when the parties have already agreed to be partners absent a contractual agreement,
however, the scope of the duty is not defined so the waters are murky in this stage.
C. Care
Because partners are already liable for their co-partners debts and decisions, RUPA recognizes
liability only for gross negligence or recklessness but firms may contract for a stronger duty
of care, or no duty of care in certain circumstances.
D. Good Faith
Partners, like all contracting parties, owe an obligation of good faith, which is different from
fiduciary duties although good faith is a fiduciary duty, all contracting parties have a duty of
honesty in fact to refrain from misrepresentations (this is likely where the obligation in
Appletree came from since the parties were limited partners).
Good faith is basically a way of interpreting the contract to meet the expectations of the
contracting parties but this doesnt mean that they cant act selfishly if the two are not
fiduciaries.
Good faith duties and fiduciary duties may be difficult to distinguish. Problems may arise in
limited partnerships a limited partners usually dont have management powers so they dont
carry a fiduciary duty, but they still have a good faith duty.
8.03: Duties of Active and Passive Owners
A. General and Limited Partners in Limited Partnerships
1. Fiduciary Duties of General Partners
General partners in a limited partnership have the same rights, powers, duties and
responsibilities as do general partners in general partnerships so they are held to the same
standards and are governed by the same UPA 21 and RUPA 404 to dictate their fiduciary
duties. However, their duties may be applied differently in a partnership vs. a limited
partnership.
*Because limited partners do not participate in management and control and rely heavily on
the general partner, there is a greater fiduciary duty owed by a general partner in a limited
partnership since the two are not equal members.
Labovitz v. Dolan

Business Organizations Book Outline

Facts: Labovitz (and another plaintiff) were limited partners in a cablevision
programming limited partnership CPI (invested over $12 million) Dolan was a general
partner. Labovitz and the other limited partners had to pay taxes out of their own
pockets even though there was plenty of money coming into the partnership to cover it
(it was supposed to per the agreement) but the general partner had sole control over
the distribution of cash to the limited partners. After this continued, an affiliate owned
and controlled by Dolan offered to buy the interests of the limited partners well below
their value. Many accepted the offer but simultaneously filed suit arguing that Dolans
tactics were a breach of fiduciary duty. The lower court said that Dolans decision to
withhold the funds from distribution was a business decision and he had wide latitude
in decision-making and dismissed the case with prejudice.
Issue: Whether management discretion granted solely and exclusively to a general
partner in a limited partnership agreement authorizes the general partner to use
economic coercion to cause his limited partner investors to sell their interests to him at
bargain price?
Holding: Overturned the court found that the plaintiffs were entitled to a trial on the
issues.
Reasoning: You can formulate an agreement to fit your needs but you cant destroy
fiduciary duties; sole discretion to make decisions (including when and the amount of
distributions) does not eliminate the duty owed. Conflicts of interest, self-dealing are
also implicated in this case the court says that the words sole discretion dont give
Dolan an unrestricted license to engage in self-dealing at the expense of limited
partners.
Note 8-4
Due to the inherent conflicts that come with limited partnerships (enforced passivity and some
who arent liable for the firms debts) courts typically characterize fiduciary duties of general
partners in limited partnerships more along corporate lines than partnership lines particularly
for the business judgment rule and the duty of care.
2. Fiduciary Duties of Limited Partners
Limited partners duties depend on whether they are characterized as partners to make them
subject to the duties of general partners but linkage is an issue because limited partners dont
have the control that triggers fiduciary duties for general partners. Often schemes will extend
the duty as far as the limited partner has control/ discretion in decision making, which
typically isnt much.
ULPA, however, provides that a limited partner owes NO fiduciary duty to the limited
partnership or to the other partners purely by virtue of being a limited partner
Since the duties owed by a limited partner are really ambiguous it is important to include in a
partnership agreement to define them.
B. Members and Managers in LLCs
Membersdirect and indirect power of control, their ability to protect themselves from the
effects of bad decisions by transferring or liquidating their interests, and the economic impact

Business Organizations Book Outline

of the decisions on the members all matter in determining the extent of fiduciary duties in the
LLC context.
1. Managers Duties
Duties of managers in manager-managed LLCs are fiduciary because managers, as agents,
have a duty to act unselfishly LLC statutes define two types of manager duties the duty of
care and the duty of loyalty
Since manager-managed LLCs operate more like corporations than partnerships, the default
rules are designed to take actual and apparent authority away from members, but if a member
acts as though a manager they are held to a managers duty of care. Managers in managermanaged LLCs typically have the same duties as partners. Non-manager members are likely
to be treated as a shareholder in regards to their fiduciary obligations.
Delaware statutes allow for total elimination of these obligations by contract
a. Care
Most LLC statutes provide that managers have a duty to refrain from reckless conduct or to
act as a reasonably prudent person would in similar circumstances reasonably relying on
reports of others to make decisions that are best for the firm.
Delaware follows the corporate business judgment rule easy to change management if need
be.
b. Loyalty
Some statutes provide that managers can benefit from transactions only with the consent of
other managers or members, while others include corporation-like conflict of interest
provisions. Either way, LLC managers likely have the same elements of duty required of other
types of business associations refraining from self-dealing; selfish use of the firms assets,
and usurping the firms business opportunities.
RULLC makes it a defense to a claim relating to conflict of interest or other comparable
claims that the transaction was fair to the LLC
Whether common law fiduciary obligations apply to managers under Delaware law as a
default rule is the subject of debate the following case lays out how a court in Delaware
came to the conclusion to that managers have default fiduciary obligations but the case
doesnt have precedential value in Delaware because it is dicta.
GENERAL RULE: Sole discretion doesnt allow you to breach your duty of loyalty.
If you own stock in a company, but have no other obligations, you have no fiduciary
obligations
You can compete with the portfolio because you dont have any controlling entities. If
you have controlling stock, the scenario changes.
One can narrow good faith duties by saying what the members duties are.

Business Organizations Book Outline

Auriga Capital Corp v. Gatz Properties, LLC
Facts: William Gatz is the head of Gatz Properties, LLC. Gatz properties manages
Peconic Bay which has a long term lease on property owned by William Gatz and his
family through Gatz Properties. Eventually, Gatz receives control of both types of Peconic
Bays stock which gave them majority control over any options. The leashold allowed the
LLC to operate a golf-course on the property. Peconic Bay goes into a sub-lease with
American Golf Corp. to operate the golf-course (complete control) and cash would flow
from American golf corp directly to Gatz Properties, LLC.
The LLC intended to act as a passive operator when it entered into its sublease with AGC
in 1998. However, rather than invest into the leased property and put its full effort into
making the course a success American Golf Corp. took short cuts, let maintenance slip,
and evidenced a disinterest in the property. It became clear to the LLC that AGC would
not renew its lease as early as 2004. PROBLEMS AFTER THIS:
o The managers of the LLC (Gatz and his family) knew that if they could get rid of
the investors, they would have valuable improved property and when it became
clear that AGC would not renew its sublease, they did nothing to look for other
routes to protect the LLCs investors.
o Managers turned down a buyer when he came forward on his own and expressed
serious interest. The manager discouraged and misled the buyer to run him off.
o The manager then made low-ball bids to the other investors in the LLC based on
misleading material information. (offered 5.6mil when the buyer offered 6mil)
Minority investors refused the 5.6 offer and asked the manger to go back
and negotiate a higher price with the potential buyer, but the manager
refused.
o When the AGC sublease was coming to an end, the manager conducted a sham
auction.
Minority investors sued claiming the manager breached his contractual and fiduciary
duties through this course of conduct.
GATZ DEFENSE: Orignally disclaimed that he owed no fiduciary duty to the minority,
claiming (1) manager and family were able to veto any option for the LLC as their right as
members and this allowed them to use a chokehold over the LLC to pursue their own
interests and the minority would have to live with the consequences of their freedom of
action; (2) defense is that by the time of the auction, the LLC was useless.
Duties Gatz Owed to the Members of Peconic Bay and the duty was not
contractually amended.
HOLDING: Judgment for Plaintiffs. LLC agreement here didnt displace the traditional
duties of loyalty and care owed by managers of Delaware LLCs to their investors in the
absence of a contractual provision waiving or modifying those duties.
o Manager could enter into a self-dealing transaction if he proved it was fair.
o Managers main defense is that it was valuelesshowever, there were years that
he could have pursued a differed route when it still had value.
REMEDY: Court orders the defendant to pay the minority what they would have received
had he done a proper transaction in 2007. That transaction would have likely yielded
proceeds for the minority of a return of their invested capital plus 10%. The Court also
takes into account the distribution received by the plaintiffs at the auction, and added
interest, compounded monthly, from the time period of the auction. Plaintiffs also
awarded attorneys fees and reasonable costs, justified under Bad Faith Exception.

Business Organizations Book Outline

Note 8-5
1. Auriga on appeal and other Delaware Cases
Auriga upheld at the Supreme Court level.
Other cases have held that managers have fiduciary duties unless the operating agreement
eliminates or restricts.
Section 18-1104 now provides that "[i]n any case not provided for in this chapter, the rules
of law and equity, including the rules of law and equity relating to fiduciary duties and the
law merchant, shall govern." Note that, despite the default rule, the parties still have the
ability to eliminate or modify those duties.
2. Elimination of fiduciary obligations
Under Delaware Law, members can restrict, expand, or eliminate fiduciary duties.
3. To whom are duties owed
Question whether managers owe duties to individual members as well as the LLC are
discussed in Allentown Ambassadors, Inc.:
o LLC manager operated a baseball league to which the debtor belonged. Manager
argued that he had a duty to act in good faith towards the LLC, not the debtor
personally. Manager tries to analogize his role as manager to one of a corporate
director.
o Court notes that this is not unreasonable under NC law; however, the court held
that a manager of an LLC owes a duty to the individual members of the LLC
that may be subject of a claim for breach of fiduciary duties.
However, under Tennessee law, the court held that members owed duties only to the LLC
and not to the other members, where the case involved contractual duties under operating
and management agreements and not oppression by a majority shareholder.
4. A duty of good faith for LLCs?
Duties of good faith and loyalty are contractual duties for LLCs. However, it also appears
that Delaware Courts would extend the duty of good faith to LLCs. This law states that a
failure to act in good faith is not conduct that results in direct imposition of fiduciary
liability. The failure to act in good faith may result in liability because the requirement to
act in good faith is a condition of the fundamental duty of loyalty.

2. Members Duties
Managing LLC members, even if theyre not designated as managers, owe fiduciary
duties to the LLC. However, members that are not acting as managers, like limited
partners, should not have fiduciary duties associated with the delegation of discretionary
power.
Basic Idea: Members that are a part of an LLC by virtue (not managers) do not have
fiduciary duties to the LLC or others involved.
Problems arise when even member managed LLCs delegate some management power to
particular members. ULLCAa member who exercises some management rights has a
managers duties, while managers are relieved of liability to the extend of authority
delegated to other members.
The LLC statute negating duty probably only negates fiduciary duties. This does not
immunize misconduct.

Business Organizations Book Outline

Members still have a contractual duty of good faith. Thus, theyre not completely free
from self-dealing in doing things such as voting on management acts, dissociating and
compelling liquidation of the firm, and transferring interests.

Pappas v. Tzolis *SKIPPED THIS CASE

Note 8-6
1. Members fiduciary duty standards
*Courts struggle on how to deal with wrongful member conduct
In re South Cannan Cellular Investments, LLC- the defendant LLC member allegedly
misused the LLCs confidential information to which the member had been granted access
to buy a debt owed by the LLC to a third party. Court held this was not a breach of
fiduciary duty because the non-controlling/non-managing member did not have a
fiduciary duty. Court also held that there was no breach of the implied covenant of good
faith and fair dealing because the Delaware statute lets member lend money and transact
business with the LLC.
In a case where a member who played a central role in providing consulting services to an
investment business, then left the business and opened up a competing business and
applied a substantially similar investment strategy, the court dismissed the claim for
breach of fiduciary duty because the defendant was clearly a non-managing and noncontrolling member and therefore could not be deemed to have breached fiduciary duties
because the parties agreements justified the use of the information.
2. Duties of Members in the Formation of the LLC
Like partnerships, there is no fiduciary duties in the formation of LLCs.
However, some states still maintain that fiduciary duties are owned during start up and
formation.
3. Duties to creditors when the LLC is insolvent
Typically, we would not expect LLCs or their members to have fiduciary duties to nonmembers such as creditors. However, one case held that:
o (a) common law fiduciary duties that are applicable to corporations apply to LLCs,
and (b) one such duty was that which arose in favor of creditors if the LLC made a
transfer to a member while the LLC was insolvent and had ceased to operate as a
going concern.
o Court held that fiduciary duties exist to protect people who are affected by the
actions of those who control the business, thus common law fiduciary duties
should allow to LLCs.
8.04: Private Ordering of Fiduciary Obligations
A. Waiver of Duties Under Uniform Laws
Concern with waiving fiduciary duties is that general partners may waive their duty and
leave other partners liable to third parties. The waiver would deny the other partners from
a remedy against the guilty partner.

Business Organizations Book Outline

RUPA, ULPA 2001, ULLCA, and RULLCAprovide that parties may not completely
eliminate the fiduciary duties of loyalty, good faith and fair dealing, but they may identify
specific categories of activity or prescribe standards for activity agreed not to be a
fiduciary breach, so long as those agreements are not manifestly unreasonable.
ULLCA, RULA, and ULPA 2001 list specific non-waivable duties, including specific
limitations on the elimination of the duty of loyalty, unreasonable reduction of the duty of
care, elimination of the obligation of good faith and fair dealing, and other matters(?)
RULLCA is more complex:
o (c) specifies what the operating agreement may not do, but in sub-section (d), it
specifies some things it may do, in some cases further qualified by a prohibition on
manifestly unreasonable provisions.
o RULLCA also notes that the operating agreement amy eliminate or limit a
fiduciary duty pertaining to a responsibility that the agreement expressly removes
from the member and imposes on one or more other members.

Note 8-7
1. Cases since Labovitz:
Lid Associates v. Dolan- Limited partners claimed that the general partners (Dolan) must
have his affiliates loan the partnership money at the same rate they paid despite being
more creditworthy than the partnership. Partnership agreement broadly allowed Dolan to
lend or borrow money on behalf of the partnership as long as it was no less favorable to
the Partnership. Court noted that partners are free to vary many aspects of their
relationship, as long as they dont destroy its fiduciary character and where a partnership
agreement exists and the agreement specifically sets forth whether the fiduciary is
required to do or not to do with respect to a matter, the terms of the partnership agreement
should be considered.
In another case, the Court held that partners will not be deemed in breach of fiduciary
duties where he complied with direct terms of operating agreement.
2. Waiving fiduciary duties: policy considerations
In most cases, fiduciary duties are waived by signing a document that is negotiated by
both parties.
Arguments in favor of not permitting waiver:
a) Partners cannot foresee the risks of conduct they would be permitting by a waiver.
However, they know this when they are negotiating the agreements.
b) Partners suffer from judgment errors that would cause them to treat the risks of
fiduciary duty waivers too lightly. However, the Court refuses to enforce
unconscionable contracts and would protect partners in those situations.
c) In typical limited partnership syndication, the interests may be marketed to
unsophisticated investors without any real bargaining. Some protection applied by
securities laws.
d) Partners are unable or unwilling to bargain carefully even regarding risks they are
aware of.
e) Fiduciary duties are necessary to protect a helpless partner from managing partners
who hold decision-making powers.
f) Enforcing waivers permits partners to unfustly or unethically harm their copartners.

Business Organizations Book Outline

Arguments in favor of permitting waiver

a) Contracting is inevitable, and parties barred in one way will seek another.
b) There may be significant benefits from waiving fiduciary duties.
i.
Litigation costs to enforce are costly;
ii.
Default duties may be unnecessary with all of the other monitoring by
partners, etc.
iii.
Courts may not understand the specific circumstances that justify particular
waiver.
3. Defining the Scope of Fiduciary Duties
Partnership agreements can steer short of waiving fiduciary duties by defining actions that
constitute a breach of duties.
4. Interpreting Waivers
Broad provisions in partnership agreements will not likely be enforced.
5. The role of fraud
Waivers can often be ruled out if fraud occurs. Can one waive liability for a fraud?
o In one case the Court held that a fiduciary cant relieve itself of the fiduciary
obligation to full disclosure by withholding the very information the beneficiary
needs in order to make a reasoned judgment whether to agree to the proposed
contract.
In other cases, the court denies waiver when the parties directly and intentionally
misrepresent or commit deliberate fraud.
6. Choice of law and fiduciary duty waiver
Parties may in effect opt out of fiduciary duties by choosing to be bound by the law of a
state, such as Delaware, which has strong law enforcing fiduciary waivers. However, if
party lacks significant contacts with Delaware, and the forum state has strong policy
against enforcing waivers, the forum court may enforce their chosen law.
7. Drafting issues: Disclosure
Under RUPA, parties can define the elements that must be disclosed in their agreement.
The following elements should be considered:
o What books and records must be kept?
o What access do all partners have to the books and records?
o Should the agreement provide that no additional disclosure obligations shall be
deemed to be imposed by any other duties, such as the duty of good faith?
o How, if at all, should the default duty to disclose other info on demand be
restricted in the agreement?
o To what extent should the managers or other partners have a general duty to
disclose information even if it is not demandedfor example, through annual
reports?
8. Drafting issues: duty of loyalty
Parties should negate as precisely as possible the duties theyre concerned about. Parties
may choose to negate only things, or discuss things that parties shouldnt participate in to
avoid a breach.

Business Organizations Book Outline

Instead of attempting to specify the activities partners may engage in, the agreement might
provide for partner authorization pursuant to RUPA. Agreement can let partners engage in
any business they want if the other partners, or a majority or supermajority of them, do not
object.
Partners in a UPA partnership may want to include RUPA language that a partner does not
violate fiduciary duties merely by acting in her own interest. The parties should
specifically state what type of selfishness is permitted.
In order to clarify the meaning of a grant of discretion to a managing partner, the
agreement could add that the partner has full power to resolve any conflicts between her
own and the partnerships interests in any way she sees fit.
9. Drafting issues: duty of care
In a manager-managed partnership, the partners might tighten the duty of care, as by
requiring the manager to conform to industry standards of management.
The agreement could define the gross negligence standard, as by explicitly permitting
partners to rely on advice or reports of others as in many LLC and corporation statutes.
The parties might attempt to reduce the partners standard of care belowthe gross
negligence level.
Rather than leaving managers duty to a vague duty of care, the agreement could specify
that the managers ower a particular time commitment to the partnershipfull or part time
depending on the circumstances.
10. Drafting issues: good faith
The good faith obligation operates in the background of every contract, and thus may exist
even after fiduciary duties of care and loyalty are waived. Good faith may be closely
related to a managing partners fiduciary duty. Partners may provide that certain activities
do not violate the duty of good faith, such as exercising a partners power to dissolve the
firm or expel a partner.
11. Reconciling RULPA 7:
Section 7 permits a partner to deal with the partnership as a third party, subject to other
applicable laws, but does not affect a general partners fiduciary duty to the firm. In once
case, the Court held that section 7 was intended to leave creditors rights against partners
subject to general fraudulent conveyance law rather than to sanction self-dealing.
12. Corporate analogs to disclosure obligations
Statutes often prescribe specific disclosure and information obligations, including the right
to keep or to maintain access to certain records. As far as carrying over corporate rules to
LLCs, one case held that the LLC rules were designed for a less sophisticated company,
where people were less likely to craft their own rules.
13. Various approaches to the waiver issue in LLCs
LLC statutes vary substantially. Most courts to apply the operating agreement if the
parties waive certain aspects of their fiduciary duties.
B. The Delaware Approach

1. Overview
Delaware Law regarding fiduciary duty as a matter of private ordering in partnership and
LLC statutes reads: the policy of this chapter to give maximum effect to the principle of
freedrom of contract and to the enforceability of partnership agreements.

Business Organizations Book Outline

Gotham Partners, LP v. Hallwood Realty Partners, LP: dictum suggested that the statute
didnt permit complete elimination of fiduciary duties. In response to this, the Delaware
legislature amended the LP Act to provide:
o The partners or other persons duties may be expanded or restricted or eliminated
by the partnership agreement; however, the partnership agreement may not
eliminate implied contractual covenant of good faith and fair dealing.
Note 8-8
1. Post- Gotham Cases: The amended provision clarifies that the Partnership agreement may
eliminate fiduciary duties, there is still interpretation issues.
2. Interpreting the Agreement
Courts should keep in mind why parties enter into agreements that waive fiduciary duty:
a) Alternative constraints on partners conduct: The agreement may limit the range of
the general partners discretion; forbid GPs from engaging in specific activities;
give limited partners a power to exit the partnership and be repaid their
investments; or permit the limited partners to remove the general partner.
b) Costs of fiduciary duties: fiduciary duties might prevent general partners from
engaging in potentially profitable transactions, etc.
c) Additional Delaware Guidance:
Court held that limited parties may not invoke the duties of good faith and
fair dealing to circumvent the parties bargain or to create a free-floating
duty unattached to the underlying legal documents.
In another case, the court held that the Master Partnership Agreement
eliminated the general partners fiduciary obligations to the limited partners
d) Drafting under non-Delaware law: treat cautiously when drafting outside of
Delaware.
3. An example: venture capital agreements
There are certain covenants to protect general partners in venture capital limited
partnerships that invest in high-risk, potentially high-reward agreements. Including:
a) Overall fund management:
i.
Can limit the amount of capital invested in a single firm;
ii.
May restrict GPs from borrowing to increase the risk and potential of the
fund;
iii.
GPs may act opportunistically in allocating investments among the funds
they manage, the agreement may require review of such investments by the
LPs or give earlier funds rights to invest in later funds.
iv. May keep GPs from excessively reinvesting funds rather than distributing
them to the LPs by requiring review of reinvestments by LP committees, or
restricting reinvestments after a certain date or above a certain percentage
of committed funds.
b) Covenants relating to activities of generap partners
i.
Limit GPs investment of personal funds in firms b/c such investments may
cause them to spend to much time on particular investments.
ii.
Limit or require LP approval of sales by the GPs of their fund shares such
as sales may affect GPs incentive to monitor the fund.
iii.
Restrict raising of money for new funds b/c this may increase GPs total
fees but reduce their attention to the existing funds.
iv. GPs may be required to spend almost ALL of their time on the partnership
covered by the agreement.

Business Organizations Book Outline

v. May required the LPs approval of new general partners.
c) Covenants restricting the types of investment: the fund may be restricted from
investing more than a certain percentage of its assets in a particular class of
investments, at least without limited partner approval.
d) Analysis of use of covenants: The number of covenants can increase the size of the
fund and whether the investments are in early-stage, high-tech funds, reflecting
increases in agency costs in these situations.
4. The Blackstone Offering
5. Partner voting on interesting transactions
The agreement may provide for partner voting on conflict of interest transactions and
other potential fiduciary breaches.
6. Exit provisions:
In addition to direct protection against misconduct, an opportunity to exit the fund can
also protect investors.
7. Confusion of corporate and limited partnership fiduciary standards

2. Fiduciary Duty Contracts in the Delaware Courts

The Delaware judiciary made clear the extent to which the parties would control their own
fate in the context of operating agreement provisions stripping the Delaware court of
dispute resolution authority and calling for arbitration outside of Delaware.

Fisk Ventures, LLC v. Segal

Case started as a motion to dissolve Gentirx, LLC by its principle owner, Fisk Ventures,
LLC. Dr. Fish, chief executive officer and controlling shareholder of S.C. Johnson and
Son, Inc. is the 99% owner of Fisk. Segal is the president and sole-officer of Genitrix.
Fisks nominal owners and board members, who are also Fisk employees, moved to
dismiss Dr. Segals claims for failure to state a claim.
Genitriz formed by Segal to develop and market biomedical technology. Segal received
55% of his the Class A membership by giving his patent rights to the partnership. Fisk
initially contributed $843,000 in return for most of the Class B, with the rest held by Fisk
Ventures, LLC and Rose.
Gentrix struggled for funding, much due to Johnson. Johnson became unwilling to provide
additional funding. This became a problem because of the Put Right provision discussed
below.
The Board is Board is 5 members, 2 from A, and 3 from B. Need 75% vote to do anything.
Thus requiring agreement from both Class A and B. Class B members could force Gentrix
to buy them out, and A must get an independent appraisal and purchase their rights.
ISSUE: Did the third parties breach the LLC Agreement, the implied covenant of good
faith and fair dealing implicit in the LLC agreement, and breached their fiduciary duties to
the company by standing in the way of proposed financing.
HOLDING: In favor of third parties and Fisk.
o A. Breach of Contractcourt says that before you can determine breach, you must
determine duty. The Gentrix LLC agreement note the breaches of dutiesand this
is not one of them. Segal is asking the Court to interpret the agreement; however,
the Court adheres to the objective theory of contracts.

Business Organizations Book Outline

o B. Breach of implied covenant of good faith and fair dealing: Court notes that the
contract of good faith and fair dealing protects the spirit of what was actually
bargained and negotiated for in the contract. Thus, there was no breach.
o C. Breach of fiduciary duty: Here, the agreement restricted or eliminated the
fiduciary duties and Segal didnt go further than a hypothetical scenario to prove
that anyone had breached.
REASONING: The Courts note that post hoc refashioning of the bargain is unflavored
because it limits parties willing/reason to contract.

Kelly v. Blum
This case makes it clear that Delaware only cares about the contract. This is an
undisclosed self-dealing transaction, but wilful misconduct is not exempted.
o Kelly Clause: I have no fiduciary duties of any kind to you. I could be disloyal,
appropriate opportunities, slack off, be negligent, and you have no legal recourse
against me.
Still could get a common law claim like fraud or misappropriation of funds.
Note 8-9
1. Choice of law and fiduciary duty contracts
Generally under the internal affairs doctrine, the governing law of a business entity is that
of its state or organization.
Delaware likes to restrict the privilege of using Delaware law in Delaware courts to
Delaware corporations, which have paid the full incorporation fee.
2. Effect of explicit fiduciary duty disclaimers under Delaware Law
Defendants problem in Kelly was that the operating agreement, while limiting the
exposure to monetary damages, did not disclaim fiduciary duties to the fullest extent
permitted under Delaware law.
3. Publicly-traded unincorporated entities
Challenges by minority shareholders to corporate mergers and acquisitions are a fiduciary
duty of public companies.
4. Corporate-style exculpation clauses
5. Eliminating fiduciary duties under New York Law

8.05: Remedies
A. The Accounting Remedy in Partnership
Accounting is where partners are held accountable for all of the matters pending in the
partnership. Decides who owes what and to whom.
Traditional Rule under UPA is that an accounting is the partners exclusive remedy,
meaning that they cannot bring an individual action against the partnership or their copartners apart from an overall wrap-up of all disputes.
NEW RULE: RUPAabolished the accounting rule.
Sertich v. Moorman

Business Organizations Book Outline

Three partners have capital investments in Civic Center Plaza (CCP), and one partner
Steve Bunch, loaned money to CCP. He assigned to the plaintiffs his right to repayment of
the loan he made to CCP while retaining his partnership interest. The party who now owns
the interest seeks an accounting because the partnership has not repaid them on the loan.
Procedural History: Lower court had held that only partners can seek accounting so this
non-partner had no standing.
Holding: Vacated lower courts decision and continued enforcement of the accounting rule
is illogical. The Court noted that the accounting requirement can no longer be raised as a
defense. The Court held that when a partnership is dissolved, the affairs must be wound up
and then all debts that are owed are listed. If the accounting rule continues to be the
exclusive remedy, then situations like this where third parties are a part of the dissolution,
leave the third parties with no remedy for the debt owed. This issue is mooted because the
court determined that the accounting rule applied to all parties with some interest in the
partnership.

Note 8-10
1. The abolition of exclusivity
RUPA 405changes the current law to align with Seritch by explicitly permitting actions
apart from an accounting. (Adopted in 37 states and the District of Columbia).
Thus the Seitrich rule has become somewhat widespread.
POLICY Of this rule:
o The partners need to resolve all claims and cross-claims they have against each
other in order to determine what each is owed or owes.
o The rule serves the purpose of deterring costly or opportunistic litigation in
partnerships.
o Even in jurisdictions that have abolished exclusivity, a court may require
something like an accounting.
o Even in jurisdictions that follow the traditional exclusivity rule, relatively simple
and discrete claims that do not require a balance are among the many exceptions to
the exclusivity rule.
2. Derivative suits
If exclusivity is abolished, it may be hard for individual partners to sue for breach of
fiduciary duty. It may mean that the partner can sue derivatively to pursue the partnership
claim without seeking the approval of disinterested partners. So far, derivative suits have
not been widely recognized by general partnerships. BUT they raise important issues in
LLCs and Limited Partnerships.
3. Drafting Considerations
Partners may be able to waive the default accounting right under UPA.
In partnerships governed by RUPA, partners may want to draft for an account exclusivity
rule or some other restriction on partner litigation.
Some agreements can list specific remedies, but the court may refuse to enforce all of
these if the list is not explicitly exclusive.
4. Indemnification
Statutes dont make it clear when parties can be indemnified for legal expenses and
liabilities triggered by their breaches of duty to the partnership.
5. Arbitration

Business Organizations Book Outline

The agreement may provide for a broad duty to have claims tried by an arbitrator rather
than in court. These clauses are WIDELY ENFORCED and BROADLY INTERPRETED.

B. Direct and Derivative Actions

In these, look who will benefit from the lawsuit to determine if it should be brought on
behalf of the organization or the individual partner/member.
o Direct: regular lawsuit. Partner, in own name, sues the other members because
they have wronged him personally as an individual.
o Derivative: Brought by shareholder/LP/Member on entitys behalf. Cause of action
belongs to the entity. Arises out of an injury done to the entity as an entity.
o Test: Who suffered the most direct injury?
To whom did the defendants duty run?
A breach of fiduciary duty to the entity may result in a proper derivative
suit.
Fershee likes looking at who the recovery goes to.
Elf Case (Pg 380): Elf claims that Jabari committed wrongs against the LLC and that the
arbitration agreement is unenforceable as a remedy for those wrongs. He brings a
derivative suit. Court held that since LLC law is designed to give parties a lot of freedom
of contract, the arbitration agreement is what should be used.
o TAKEAWAY: Courts arent persuaded by changing the LLC Agreement.
Page v. Pagethe page boys, H.B. (plaintiff) and George (defendant) were brothers and
partners in the linen supply business. Each had invested 43k in the business at the outset and it
had suffered losses of 62k over its eight-year existence. H.B.s wholly owned corporation held
a 47k demand note from the partnership. The partnership had recently started to show a profit.
H.B. sues to dissolve:
The Court held:
o Judgment for H.B.: A partner can generally dissolve the partnership whenever e or
she wishes to do so.
o That rule applies here, since there is no evidence that the partnership was a
partnership for a term. BUT
The power to dissolve is subject to fiduciary duties;
Therefore, HB now does the following:
o Foreclose on note; put partnership into bankruptcy, which dissolves it by operation
of law; buy partnership assets in liquidation; continue business
Is this viable even if he pays a fair price?
o Get appraisal and offer to buy out George at fair price.
What if George refuses to sell?
Reconcilable with expulsion cases?
o Page v. PageA partner may not, however, by use of adverse pressure freeze
out a co-partner and appropriate the business ot his own use. A partner may not
dissolve a partnership to gain the benefit of the business for himself, unless he
fully compensates his co-partner.
o Lawlis v. Kightlinger & Gray: Where the remaining partners in a firm deem it
necessary to expel a partner under a no cause expulsion clause in a partnership
agreement freely negotiated and entered into, the expelling partners act in good
faith regardless of motivation if that act does not cause a wrongful withholding of
money or property illegally due the expelled partner at the time he is expelled.

Business Organizations Book Outline

1. Limited Partnerships
RULPA doesnt give an express provision for direct actions by partners against the
partnership or other partners, rather it links back to general partnership law.
UPAthe main general remedy is an accounting suitthis effectively bundles litigation
with exit or dissolution, consistent with the aggregate nature of partnership.
RUPA modifies UPA by providing for direct action at law with or without an accounting.

Anglo-American Security Fund, LP v. S.R. Global Intl Fund, LP

DIDNT DISCUSS
LP in question was a hedge fund in which the general partner accepted money from the
limited partners, themselves sophisticated investment funds, for investment in securities
and other financial instruments. The LPs claim that the general partner over-withdrew
from its capital account.
The test for distinguishing derivative and direct claims in a limited partnership is
essentially the same as a corporation. Test looks to the nature of the injury and to the
nature of the remedy that could result if the plaintiff is successful.
o The claim is direct when claim is one that alleges either an injury that is different
from what other shareholders suffered (or partners) or one that involves
contractual rights of shareholders (or partners).
o The claim is derivative when the injury is one that affects all partners
proportionally to their pro rata interests in the corporation.
Plaintiff sues for injury done to the partnership and any recovery goes to
the partnership.
The Court notes that when using corporate laws to apply to partnerships, there must
be flexibility. This follows from the flexible nature of limited partnerships.
Holding: The operation and function of the fund as specified n the Agreement is so far
removed from the traditional corporate model that it must be brought as a direct claim.
o Due to the structure of the fund, whenever the value is reduced, the injury accrues
irrevocably and almost immediately to the current partners but will not harm those
who later become partners.
Analysis: In another case, the court identified two purposes for classifying claims as
derivative in a limited partnership: (1) to ensure that any remedy accrues to the entity that
sustained the injury and doesnt benefit the wrongdoers nor provide windfalls to the
uninjured and (2) to provide a gatekeeping function that will both promote corporate
resolution of internal problems and deter strike suits.
Note 8-11
1. Direct recovery for derivative claims
In Anglo, the Court observed that harm to the entity will amonst inevitably harm the
stakeholders and because the entity itself is in some ways no more than an amalgamation
of a certain subset of stakeholders interests, differentiation of direct from derivative
claims can be elusive.
2. Derivative versus claims in Madoff Ponzi scheme and other duty of care lawsuits
The Madoff issue brought a number of suits that dealt with direct vs. Derivative claims.

Business Organizations Book Outline

o Court dismissed all of the direct claims by the limited partners against the general
partners (tried suing saying that they should have noticed red flags), holding that
they could only be asserted derivatively because the injuries were inflicted on the
partnership, and distinguishable from Anglo.
o Dictaclaims of fraud and inducement to invest in the LP might be brought
directly.

2. LLCs
Members have the right to sue the LLC or other members to enforce their rights under the
operating agreement, the LLC act, or rights created independently.
When the action involves an injury to the LLC as opposed to the individual, the statute
authorizes derivative actions.
When LLCs are manager-managed, the same rationale applies as in allowing shareholders
to bring derivative suits on behalf of the corporation against officers and directors. That is,
the lower to bring lawsuit, or take any action for that matter, is vested in management.
DIFFERENCE: Unlike corporations and LPs, LLCs are by default managed directly by
their members. In a derivative suit, a single volunteer owner, rather than a direct
member brings litigation.

Note 8-12
1. The New York Confusion
Courts in NY held that embers of an LLC could bring a derivative suit on the LLCs behalf
even though there is no provision permitting that under NY law.
The main question is whether the statute should provide for a derivative remedy. If there is a
strong need for this, then any ambiguity in the statute should be in favor of protecting the nonmanaging members.
2. Individual vs. Entity Claims
Where a suit is on behalf of the member, he can bring a claim for injury. Characterization
generally on whether the member seeks to recover on a claim for injury to and for breach of a
duty owed directly to the member.
3. Member-authorized suits
LLC statutes provide for suit by a majority of the disinterested members. (based on an older
provision of the LLC act). This entails more member involvement in the decision to sue than
the derivative remedy, which permits a single member to proceed following demand on the
decision makers even if they refuse to authorize the suit.
4. Individual suits on entity claims
Courts MAY allow members to sue directly on claims that might be characterized as on behalf
of the entity. Usually, these cases are only permitted when there is no danger of further suits
or of prejudicing third parties rights.

Business Organizations Book Outline

Issue of prejudicing creditors by taking all of the funds is the nature of the limited liability
firm. RULLCA provides for a direct action to enforce the members rights and otherwise
protect the members interests, but only if the member pleads and proves and actual or
threatened injury that is not solely the result of an injury suffered.
In Anglo the Court noted that one effect of permitting a derivative action would be to deny
recovery to withdrawn partners who had actually suffered the loss and permit subsequently
invested partners to receive windfalls.
Other casesall of the following cases involve closely held businesses. Even if there is a
sound reason for maintaining the direct-derivative distinction in cases brought by partners or
members of widely held limited partnerships or LLCs, is the distinction worth the cost and
trouble in closely held businesses like those below?
Court concluded that only an LLC had standing where a sole LLC member asserted
standing to sue the LLCs lawyer directly for malpractice because the member lost profits
that would have flowed through the LLC to the member.
Parties formed an LLC and executed an operating agreement under which they planned to
convert a horse track into a motor sports venue. After the venture failed, the NJC sued
Ganassi, claiming direct injury arising from his accounting malfeasance in inflating its
members contribution obligation. Court permitted this action holding that the alleged
injury arose directly out of a breach of the operating agreement.
Court held that (a) a minority of members did not have the authority to cause the firm to
sue the other members for breach of fiduciary duty, (b) the members did not have standing
to assert individual claims based on duties owed by other members to the firm, and (c)
nevertheless, each of the contending groups could assert derivative claims against the
other on behalf of the firm.
5. Who hires the lawyer?
In an LLC derivative suit, who handles hiring the lawyer for the LLC? Case law shoes that if
the operating agreement vests management rights in the majority of the members, one of two
50% owners cant hire the lawyer. The main argument is if the lawyer is employed by the
LLC, the fees should be paid out of the LLC and thus split by the members. SOLUTION:
each member can hire his or her own lawyer.
6. Other remedies: accounting and oppression suits
Accounting: In partnerships, the extensive accounting remedy is generally brought
when the firm is dissolving, though it is technically available in a going firm. This
assumes that the basic mechanism for resolving disagreement is a members unilateral
ability to dissolve the firm.
Oppression: The oppression remedy provides for judicial dissolution in the event of
member misconduct in situations where the member does not have an automatic unilateral
power to dissolve.
Both oppression and accounting bundle dissolution and litigation of the firm. Therefore,
they are probably not suitable where parties need to litigate but plan to continue.
7. State-to-state variations
One variation requires a vote of disinterested members or managers to authorize litigation
rather than authorizing a single member to sue on behalf of the firm.

Business Organizations Book Outline

8. Creditors and the derivative remedy in Delaware
Under Del. Corp. law, creditors of an insolvent corporation have standing to maintain
derivative claims against directors on behalf of the corporation for breaches of fiduciary
duties.
Delaware LLC act provides for derivative actions brought by members or assignees of
LLC interests in the right of LLCs against managers or members.
The Delaware Courts note that courts should shy away from applying corporate laws to
other entities because the other entities were derived to be different from corporations for
a reasons.
9. Effect of dissolution on the derivative remedy
Court notes that when the effect of the dissolution problem doesnt indemnify any
member who previously harmed the partnership. Thus, as part of the winding up, creditors
should be able to receive what theyre entitled.
C. Contractual Remedies
Looking back at the Elf case, the court noted that the operating agreement provision that each
LLC member consents to the exclusive jurisdiction of the state and federal courts sitting in
California in any action on a claim arising out of, under or in connection with this Agreement
or the transactions contemplated by this agreement did not violate the law.
Following Elf, the Delaware legislature amended its limited partnership and LLC statutes,
respectively, to bar limited partners and non-manager members from waiving their right to sue
in Delaware courts as to matters relating to internal organization of their firms.
Note 8-13
Elf shows the application by a state court strongly favoring arbitration agreements reflected in
the Federal Arbitration Act.
One downfall of arbitration agreements is that they are costly to interpret and pursue in
comparison with statutory remedies.

Business Organizations Book Outline

PART III THE DEATH AND RESURRECTION OF THE ENTERPRISE
Chapter 9: Dissociation and Dissolution in Partnership and Limited Partnership
9.02 Dissociation and Dissolution in General Partnerships
A. UPA
Under UPA 29 and 31, the partnership dissolves at the will or departure of any
partner
Then either continuation or liquidation occurs
If no unexpired agreed term or uncompleted undertaking, the partnership is liquidated
o UNLESS all of the partners including the partner who caused the dissolution
agrees to continue the business
o If they agree to continue, the leaving partner is paid off
o If they do not agree, the business is wound up and the assets are sold and
distributed according to UPA 40
If there IS an unexpired term or uncompleted undertaking, the dissolution may be
wrongful
o If it is wrongful, the partnership may be continued without liquidation if all of
the partners EXCEPT the one who wrongfully dissolved the firm agree to
continue
o If the partnership continues, the dissolving partner is paid the value of his
interest MINUS damages caused by his wrongful dissolution (and not
including goodwill)
o If firm is liquidated then same process as if dissolution wasnt wrongful
Whether the partnership continues or is liquidated, UPA 33-36 determine partners
continuing liability for pre-dissolution debts and potential liability for post-dissolution
debts
B. RUPA
Unlike UPA, RUPA allows for partner dissociation separately from dissolution
o In contrast to UPA, these rules only come into play when the partnership is
ending
o However, a partnership may wind up by selling its assets as a going concern to
a third party
Apart from general structure of the dissociation and dissolution provisions, RUPA also
differs from UPA in making it more likely the partnership will continue rather than
dissolve when a partner leaves
o Partnership doesnt dissolve unless majority of partners agree to wind up or
dissolve within 90 days after the dissociation
o Partners may also waive dissolution and retroactively undo winding up any
time prior to termination
Except cannot contract to avoid judicial dissolution or dissolution for
unlawfulness
C. Policy Considerations
Statutory dissolution and dissociation provisions attempt to balance the costs of
partners illiquidity against the costs of partnership discontinuity
o Illiquidity can be expensive because locking partners into the firm amplifies
disagreement and leads to deadlock and litigation

Business Organizations Book Outline

Dissolution at will can be costly because it can terminate executory contracts and force
firms to sell off crucial assets to pay off the departing partners
o Exiting partners can also take their skills, clients and credit that are crucial to
the firms future
D. Clarifying Teminology
Under UPA, dissolution and winding up apply whether or not the underlying
business continues
o Dissociation is not used by UPA because dissolution terminates the existence
of the legal entity, regardless of the condition of the underlying business.
o So, winding up under UPA can refer to both process of buying out a partner
and continuing the business in a new partnership, or to the process of
liquidating the underlying business itself
RUPA cleared up this ambiguity by using dissolution and winding up only in
connection with a partnership that will continue either as a legal entity or with respect
to its underlying business
o dissociation is only applied with respect to the events of dissociation
enumerated in RUPA 801

9.03 Dissolution and Dissociation Cases

A. Dissolution at will: Term and At-Will Partnerships
Page v. Page (1961)
o Partners in a linen supply business, plaintiff appeals from judgment declaring
partnership to be for a term rather than at will
o Oral partnership agreement in 1949
o Partnerships major creditor is corporation wholly owned by plaintiff
o Court found that defendant failed to prove any facts from which an agreement
to continue the partnership for a term may be implied. Defendant conceded that
they never discussed the continuation of the business in the event of losses
o The defendant merely had a hope that the business would have enough
earnings to pay for all the necessary expenses
all partnerships are ordinarily entered into with the hope that the will
be profitable, but that alone does not make them all partnerships for a
term and obligate the partners to continue in the partnerships until all o
the losses over a period of many years have been recovered
o Because the plaintiff did not act in bad faith when he wished to terminate the
partnership, judgment is reversed and declared a partnership at-will
NOTE 9-1
o 1. If partnership is for an agreed term or undertaking, it logically follows that
parties have concluded that it would be particularly damaging to end the
partnership prior to the expiration of the term.
o 2. Page court implied that liquidation might not be required even if dissolution
is technically not wrongful.
Disotell v. Stiltner permitted a continuation and buyout rather than
liquidation even in the absence of a showing of wrongful dissolution,
reasoning that buyout would reduce economic waste because the
costs of sale would be as much as 12% of the propertys value, and
avoided the risk that no buyer would pay FMV in a liquidation sale

Business Organizations Book Outline

B. Partner Death
A partners death dissolves a partnership
However, it is less clear whether the surviving partners have the right to continue the
business after the death of a co-partner
o UPA 37 and 38(1) give the right to force liquidation only to a partner as
distinguished from the representative of a deceaseds estate
o But UPA 41(3) implies that the estates consent is requires for continuation,
and the estates legal representative can obtain judicial winding up under UPA
37
o RUPA 601(7) states the death of an individual partner causes partners
dissociation from the firm
o 601(8)-(10) provide for figurative death of partners who are business
associations or trusts by termination or distribution
o Unlike UPA, these events do not dissolve the partnership for a term or
undertaking under RUPA 801(2) unless at least of the partners agree to
wind up or dissociate within 90 days of the dissociation
C. Bankruptcy
Bankruptcy of a partner or the partnership causes dissolution under UPA 31(5)
o This is consistent with logic that non-bankrupt partners, who continue to be
personally liable, may not want to continue in partnership with a partner who is
no longer financially responsible
Since bankruptcy is not a cause of wrongful dissolution, any partner including the
bankrupt partner can compel liquidation
o However, parties can agree, following the bankruptcy of a partner, the firm
may purchase the interest of the bankrupt partner and continue the
partnerships business
RUPA 602(b)(2)(iii) says that dissociation is wrongful if it occurs prior to the
expiration of a definite term or completion of particular undertaking, which may
trigger a right to damages
o Doesnt dissolve the partnership unless a least of partners agree to wind up
or dissociate within 90 days
Federal bankruptcy law may trump state partnership law and the parties partnership
agreements.
Some bankruptcy cases hold that, despite state law to the contrary, a partners or
partnerships Chapter 11 proceeding does not dissolve the partnership because
dissolution would interfere with the reorganization of the bankrupt partner or
partnership
o This reasoning is questionable since dissolution would not prevent sale of the
bankrupt partners interest or of a dissolved partnerships business as a going
concern
Most courts hold under Bankruptcy Code (11 U.S.C.) 365 that the bankrupt partner
who is managing the business as a debtor in possession continues as a partner even
if the bankruptcy purports to cause a dissolution or dissociation under state law
D. Judicial Dissolution
Wrongful dissolution and its adverse consequences can be avoided by obtaining a
judicial dissolution
o Some of the UPA dissolution causes are dissociation causes under RUPA

Business Organizations Book Outline

o RUPA approach avoids dissolving an entire partnership merely because of the
wrongful conduct or incapacity of a single partner
9.04 Winding up and Liquidation
Liquidation effectuates a complete separation of the partners, which is one of the main
functions of dissolution and liquidation
Where the partnership is to be liquidated rather than continued, it may be a breach of
fiduciary duty for a partner not to proceed with winding up, but conflicting case law
notes an inconsistency on the matter
Example of partner contributions on capital losses:
o Three-member partnerships assets are $5,000, two of the partners, A and B,
each have made capital contributions of $2,500 and there are $12,000 of debts
to outside creditors.
o The three partners must contribute equally toward the excess of liabilities
(including those to repay capital contributions) to assets.
o In this situation, A and B would each have to come up with $1,500 ($4,000$2,500), while C would have to come up with $4,000 to pay A, B, and the
outside creditors.
Under UPA and RUPA, partners can provide for their own liquidation scheme in the
partnership agreement.
9.05 Continuation and Buy-Out of Dissociating Partner
When partnership continues, default is firm must pay the outgoing partner for his
share of the partnership, plus profits or interest for the partners use of this share from
the time of dissolution until the time of payment.
Wrongful partners are not paid for goodwill and must pay damages caused by
prematurely dissolving the firm
o Valuation is then done on a going concern basis despite the fact that the firm
technically dissolves under the statute
A. Valuation
RUPA 701 says the standard for determining the value of the outgoing partners
interest by providing that a dissociated partner is entitled to the amount that would
have been distributable to the dissociating partner under 807(b) IF, on the date of
dissociation, the assets of the partnership were sold at a price equal to the greater of
the liquidation value or the value based on a sale of the entire business as a going
concern without the dissociated partner and the partnership were wound up as of that
date
1. The Minority Discount
There is an issue whether the price the leaving partner receives depends on the value
of the entire firm or on the partners interest in the firm.
o This can make a huge difference because the market value of the partners
interest is affected by the marketability of the interest itself.
o Since buyout is supposed to address illiquidity, arguably the price should be
based on the value of the entire firm
o On the other hand, a rule that provides for lower buyout prices would
discourage partners from leaving, saving the firm the costs of discontinuity

Business Organizations Book Outline

RUPA 701 settles the minority discount issue by providing the liquidation valuation,
which assumes a valuation of the assets and liabilities of the entire firm.
2. Wrongful Dissolution
Meaning to leave the firm prior to the expiration of an agreed term or undertaking,
may have two effects on valuation in addition to its impact on continuation of the firm
Wrongful partner must pay damages cause by premature departure, this may entail a
determination of profits the firm would have made if the partner had stayed or the firm
hadnt been dissolved
NOTE: RUPA 602 applies only to partner dissociation, RUPA does not literally
provide for a right to damages for wrongful dissolution.
UPA 38(2) also penalizes a wrongful partner by not only assessing damages, but also
denying the partner a share in the firms goodwill
3. Partnership Liabilities
Partners continue to be liable for pre-dissolution liabilities even after they leave the
firm until the creditors release them
o If a new partner joins the firm when it continues after a dissolution, the new
partner is also liable for the firms old debts, but such liability can only be
satisfied out of partnership property
o The new partner cannot be held personally liable for the old debts, unless he
expressly agrees to be so held
However, the partnership has a default duty to indemnify the leaving partner against
these liabilities
o The leaving partner may pay for this indemnification by a reduction in the
buyout price to reflect the firms liabilities
This amount can be difficult to determine because of contingent
liabilities such as tort or malpractice that havent been judged yet
4. Goodwill
Spayd v. Turner, Granzow & Hollenkamp (1985)
o Spayd appealed two lower courts decisions that, due to ethical considerations,
there could be no accounting for goodwill upon the dissolution of a law
partnership
o Issue: whether upon dissolution of a law partnership, a partner is entitled to
demonstrate that goodwill is an asset of the partnership in the absence of a
provision in the partnership agreement to the contrary and whether the legal
rules of ethics preclude the existence of goodwill in a law partnership
o Courts have traditionally relied on two theories to say that goodwill is not a
measurable or distributable asset with regards to law firms
One, the amount of goodwill that exists is attributable to the
professional skill and reputation of each member of the partnership;
Two, the existence of ethical prohibitions against distributable goodwill
in law partnerships
o Court concludes as a matter of law the ethical standards do not preclude a
finding that goodwill exists in a law partnership upon dissolution of that
association
o Plaintiffs partnership rights and interests must be determined by the
provisions of the agreement, rather than any statutory enactment under UPA

Business Organizations Book Outline

o Hold goodwill as an asset of a partnership to be distributed upon dissolution of

the business is a matter of contract between the partners and must be
SPECIFICALLY set forth in the partnership agreement
NOTE 9-2
o 1. Paying for goodwill.
Contradicting case law shows inconsistency of courts finding that
goodwill exists in law firms
Need to have a provision in the partnership agreement
o 2. What goodwill belongs to a leaving partner?
Says that goodwill belongs to the firm not the partner, very difficult to
measure human capital
o 3. Effect of RUPA
RUPA may change the valuation rules applied under the UPA
First, by providing for payment of going concern value
determined without the dissociated partner, 701(b) implies
that the reputations of the non-dissociating partners are taking
into account
Second, because the valuation standard under RUPA 701(b) is
based on a sale of the underlying assets, it does not reflect a
minority or control discount

9.06 Liabilities of Dissolved and Continuing Firms

With some exceptions, partners in the old partnership continue to be liable for old
liabilities, while partners in the new partnership are personally liable for new liabilities
and exposed to old liabilities to the extent of their investments in the firm
A. Former Partners Liability for Pre-Dissolution Debts
Former partnership remains liable for pre-dissolution debts after the dissolution
Dissolution does not necessarily end the old partners individual liability for
partnership debts
Court reasoned in In re Judiciary Tower Associates that the partnerships obligation to
perform the contract was the joint liability of all of the partners at the time of the
contract, and that a creditor contracting with a general partnership does so in the
rightful expectation that all of the general partners stand behind that contract, and that
a partners withdrawal will not release that partners responsibility on the contract
except as set forth in UPA 36
o The rules suggest the need for drafting and planning by partners and creditors
o Creditors may want to bind partners individually to a lease or other long-term
contract in order to avoid ambiguity about whether a partner continues to be
liable on the lease after leaving the firm
o Conversely, a partner who is nearing retirement may want to think twice about
continuing with the firm and becoming obligated on the lease, and a new
partner may hesitate before joining a firm that has entered into a burdensome
office lease
Creditors can agree to release an outgoing partner expressly or implicitly by agreeing
to an alteration in payment of debt knowing the partner has dissociated
The partner who is not released can seek indemnification from the partnership

Business Organizations Book Outline

o UPA applies only to wrongfully dissolving and expelled partners, apparently

presuming that rightfully dissolving partners can negotiate for indemnification
as the price of permitting the other partners to continue
B. Former Partnerships Liability for Post-Dissolution Debts
If the partnership continues after a partners dissociation, the continuing partners have
the power to bind the new firm just as they did prior to the dissociation and
dissolution
The old firm continues for purposes of winding up, during which time the partners
have the real authority to bind the firm only in winding up transactions such as
compromise and release of claims, and not in transactions that are aimed at keeping
the firm going
The former partner may retain some apparent authority to bind the firm as to creditors
who lacked knowledge or notice of the partners dissociation
C. New Partners and Partnerships Liability for Pre-Dissolution Debts
If a partnership dissolves and one or more of the original partners carry on its
business, UPA 41 provides that the new partnership is liable for the debts of the
original partnership
UPA 17 and RUPA 306(b) provide that new partners are liable only to the extent of
their investments in the firm
o This applies to new partners admitted to existing partnerships whether or not
the partnership has dissolved
1. New Partners
If the default rule provides that a new partner is not liable on a pre-admission contract,
creditors may want to contract directly with new partners to ensure that they are on the
debt
2. Successor Partnerships
UPA 41 provides that successor partnerships are liable for the debts of the old firm
o This provision applies when a partnership is continuing the business of a prior
partnership with some continuity of partners
o It does not apply when a wholly new person such as a corporation, continues
the partnership business, or after a partnership has dissolved and wound up
RUPA does not deal with successor firms, rather under 801, the partnership does not
dissolve at all following a partners dissociation in some circumstances
o Since the firm continues, there is no successor firm
The partnership agreement may limit the liability of partners and successor firms and
will be enforced among the parties to the agreement
3. Partnership Merger
There is no formal method for merging partnerships under UPA, So partnerships have
had to invent procedures involving admission of partners and combination of assets
and liabilities
o Presumably under this procedure, partners of each firm are personally liable
only for the liabilities that arise after the merger under UPA 17
o A partner of the surviving partnership is personally liable for and must
contribute toward the obligations for which he was liable before the merger
o A partner is NOT, however, personally liable for pre-merger liabilities of any
other constituent

Business Organizations Book Outline

9.07 Buyout and Continuation Agreements
Partners may want to
o (1) provide that the partnership business continues notwithstanding the
occurrence of an event of dissolution under the statute, particularly including a
partners dissociation in order to avoid the problems involved in Page; AND
o (2) vary the default provisions concerning the valuation of the exiting partners
interest
o Although partners can discuss these matters when a partner dissociates, at the
end of a relationship is not the best time for parties to work things out; these
agreements should be put into place at the onset of the partnership, put in the
partnership agreement
A. General Considerations
Starr v. Fordham (1995)
o Paragraph 3 of the partnership agreement expressly authorized the founding
partners to calculate a departing partners fair share of the net value of the
unrealized accounts receivable and work in process less liabilities
o The plaintiff argues judges conclusion that the sum of the firms future lease
payments to be included in the liabilities for that calculation was clearly
erroneous
o Judge decided the lease payments constituted liabilities because a liability was
a contractual obligation to pay monies
This barred plaintiff from receiving any % of the firms work in process
or AR because the firms existing liabilities, including a long term
lease, exceeded the firms work in process and AR by nearly 2:1,
without any reserves or allowances
The partnerships office was indisputably a monetary obligation for
which each partner was jointly liable
o Had the judge interpreted liabilities to exclude the lease, the creditors interests
in the firm would be junior to the partners interest.
NOTE 9-3
o 1. Enforcing the Agreement
Under UPA, the agreement cannot avoid dissolution. Thus, even if the
agreement provides that the firm does not dissolve, the courts usually
interpret these agreement as providing that the partnership business
continues after dissolution
RUPA provides that partners may avoid dissolution by contrary
agreement
o 2. Drafting the agreement: providing for the trigger
Dissolution and buyout agreements generally contain at least two
important elements:
The trigger states that certain events cause either dissolution
or buyout of the partners interests
And the consequences that follow from the trigger
The agreement might provide for buyout or dissolution triggers such as
deadlock that are not provided for in the statute

Business Organizations Book Outline

Or it may try to avoid UPA consequences for UPA dissolution of
buyout causes
Parties must be careful to cover all UPA events
Ex. Might try to dissolve under UPA in order to escape the
consequences of withdrawal or retirement under the agreement
In general, the partnership agreement, like the partnership statute, must
balance the need for partner liquidity against the threat to the firms
continuity if it has to buy out anyone who wants to leave.
o 3. Valuation Provisions
When the agreement provides for buyout rather than liquidation, it
should also include some provision for fixing the buyout price
Example scenarios on pg 449-50
B. Expulsion or Forced Buyout
UPA 31(1)(d) provides that agreed expulsion is a cause of dissolution and
UPA 38(1) provides by default for continuation of the business with a cash payment
to the expelled partner
RUPA 601(3) also provides for expulsion pursuant to the partnership agreement, and
this is not a cause of dissolution
These provisions are important because some partners may be hard to get rid of
without such a provision
Cadwalader, Wickersham & Taft v. Beasley (1998)
o Case involving downsizing of a company, including the Palm Beach office
were defendant Beasley worked
o Trial court Judge Cook ruled that CW&T was authorized to close the Palm
Beach office pursuant to the partnership agreement, and that Beasley would
have voluntarily left CW&T by year-end 1994 in any event
o However, since the partnership agreement lacked provisions for the expulsion
of a partners (except on limited situation), he found that CW&T had
anticipatorily breached the partnership agreement when it announced its plans
to close the Palm Beach office in August, and then actually breached the
agreement when it sent Beasley the November letter.
o The final judgment awarded Beasley his paid-in capital plus interest, his % in
the firms AR and assets and interest thereon, and punitive damages, all
totaling $2.5 million
o The Appellate Court agreed with the trial court except, for the that Beasley
should not be entitled to profits resulting from the post-dissolution services of
remaining partners
To the extent that some of the firms post-dissolution profits may be
attributable to the post-dissolution efforts, skill, and diligence of the
remaining partners, the firms fee as a result of those services should
not be proportionately attributable to the use of the departing partners
right in the property of the dissolved partnership
NOTE 9-4
o 1. Expulsion other than pursuant to the partnership agreement
Partners have the right to choose with whom they associate
o 2. Bad Faith Expulsion

Business Organizations Book Outline

As Beasley indicates, an expulsion may be in bad faith if its purpose
was solely to benefit the expelling partners
o 3. Expulsion of Whistleblower
Policy concerns with expelling whistleblowers are that it might actually
hurt clients instead of help to protect them and this would override the
firms strong interests in maintaining internal efficiency
The firm itself is best situated to protect clients by monitoring its
partners, and restricting expulsion might actually interfere with the
firms ability to serve its clients by disciplining its members
C. Post-Dissolution Work-in-Process and Competition
Meehan v. Shaughnessy (1989)
o Meehan and Boyle were partners at Parker Coulter, after they terminated their
relationship with Parker Coulter to start their own firm Meehan Boyle &
Cohen (MBC), they sued (1) to recover amounts they claim their former
partners owed them under the partnership agreement, and (2) to obtain a
declaration as to amounts they owed the partners for work done at Parker
Coulter on cases they removed to their new firm.
o Parker Coulter counterclaimed that Meehan and Boyle violated their fiduciary
duties, breached the partnership agreement, and tortuously interfered with their
advantageous business and contractual relationships.
Parker Coulter also brought 3rd party claims against two other former
employees that left to join the new firm
o On appeal, Court reverses TCs conclusion that Meehan and Boyle acted
properly in acquiring consent to remove cases to MBC
o The strong public interest in allowing clients to retain counsel of their choice
outweighs any professional benefits derived from a restrictive covenant.
Thus, the Parker Coulter partners could not restrict a departing
partners right to remove any clients who freely choose to retain
him/her as their legal counsel.
o Court interprets agreement to provide that, upon the payment of a fair charge,
any case may be removed regardless of whether the case came to the firm
through the personal efforts of the departing partner.
This privilege to remove of course depends on the partners compliance
with fiduciary obligations
o Court disagrees with Parker Coulters first two arguments that these attorney
breach their duties (1) by improperly handling cases for their own, and not the
partnerships benefit and (2) by secretly competing with the partnership
o However, Court agrees with the third argument: (3) by unfairly acquiring from
clients and referring attorneys consent to withdraw cases to MBC
Meehan affirmatively denied to his partners, on their demand, that he
had any plans for leaving
Upon informing Parker Coulter of their departure, Meehan and Boyle
immediately began communicating with clients and referring attorneys,
and delayed providing PC partners with a list of clients they intended to
solicit, by which time he had obtained authorization from a majority of
the clients

Business Organizations Book Outline

Finally the letter sent to the clients was unfairly prejudicial to PC
because it did not fairly represent that the clients could remain with PC
instead of moving to MBC
o Further, the burden of proof is placed on the MBC attorneys to prove that their
breach of fiduciary duties to PC did not directly affect PCs loss of clients and
that the clients would have chosen to take their services to MBC regardless
o If Meehan and Boyle meet their burden, the resolution is solely over fees.
Under the partnership agreement, Meehan and Boyle must reimburse
PC for time billed and expenses incurred at that firm on all cases which
were fairly removed and any excess of the fair charge is Meehan and
Boyles to keep
o If Meehan and Boyle do not meet their burden, and the clients were unfairly
removed, a fair charge would not make PC whole and MBC must account and
hold in trust any profits which flow from a breach of fiduciary duty and MBC
must give any profits from those cases to PC
profits means amount by which the fee received from the case
exceeds the sum of (1) any reasonable overhead expenses MBC incurs
in resolving the case and (2) the fair charge it owes under the
partnership agreement
o Holding is MBC must hold in trust the profits they derived or may derived
from any cases subject to determination of whether they were unfairly removed
or not
NOTE 9-5
o 1. Competition for Clients
Meehan demonstrates some important lessons in drafting an agreement
for a professional partnership to deal with the departure of partners and
the removal of clients
The cases indicate that duties among the partners and to clients
may sometimes conflict in that enforcing strict competition
duties among the partners may leave the clients without the
lawyer of their choice, or reduce the lawyers incentives to act
for the client
o 2. Duty not to Take Clients
Should the partnership agreement have had language that explicitly
dealt with clients the leaving partner had not recruited to the firm?
o 3. Incomplete Partnership Agreements
Agreements should probably have the method for fair charge laid out
or similar payment scheme
o 4. Partners Fiduciary Duties
MBC court held Meehan had duties in addition to those prescribed by
the partnership agreement regarding their taking of clients.
Must be very leery of fiduciary duties in these situations because they
can very easily be construed against departing partner
o 5. Contractual Waive of Non-Competition Duty
Would an agreement in the PC partnership agreement that allowed
departing partners to take clients without informing their former
partners violate ethical duties to the clients?

Business Organizations Book Outline

o 6. Duties of Associates
Iowa case said that while there was a concern with leaving partners
grabbing clients, the clients right to terminate a relationship with a
lawyer is absolute
The old firms right is limited to quantum meruit compensation for the
value of attorneys services rendered prior to termination, unless the old
firm can prove that the associates unilaterally contacting clients in
violation of applicable ethical rules cause the firm to lose clients it
otherwise would have retained
9.08 Special Issues in Limited Partnership Dissociation and Dissolution

A. Dissociation of Limited Partners

1. RULPA
Departing partner should be paid distributions to which he is entitled and, if not
otherwise provided in the agreement, the fair value of his interest in the partnership
Difference between fair value and fair market value
o Fair market value the value the limited partnership interest would actually
bring in a sale between a willing buyer and willing seller
o Fair value a proportionate interest in the value of the firm as a going concern
Also, a limited partnership whose limited partners have all withdrawn would cancel its
certificate of LP and either continue as a general partnership or dissolve and wind up
pursuant to the general partnership statute
2. ULPA 2001
ULPA merely lists withdrawal as one of a list of events that constitute dissociation of a
limited partner
Nevertheless, an LP has no right to dissociate before termination of the limited
partnership
B. Dissociation of General Partners
1. RULPA
A limited partnership is dissolved on an event of withdrawal of a general partner
unless the partnership is continued by consent of all the partners or pursuant to the
partnership agreement
2. ULPA 2001
The firm does not dissolve in the event of general partner dissociation unless partners
with a majority of distribution rights consent to do so within 90 days after the
dissociation, or if no general partner remains after the dissociation and limited partners
owning a majority of distributions rights fail within 90 days to consent to continue and
to admit a new general partner

Business Organizations Book Outline

Chapter 10: LLC Dissociation and Dissolution
10.01: Introduction
Dissociation and dilution of LLCs is different than that of partnerships (trigger partnership
dissociation by end of willingness to participate b/c thats how partnerships are created)
Theres no equivalent in corporate law you want out you sell your shares if its publicly held
(and closely held by default rules) it doesnt trigger anything by expressing the will to
withdraw. LLC as a hybrid is problematic.
10.02: Dissociation
A. DEFAULT RULES
Old rule: LLC statutes typically provided for certain events of member
dissociation because of tax implications (withdraw negated continuity of
life element of a corp and allowed the LLC to be taxed like a partnership)
The statutes listed dissociation events and provided for 2 consequences of
dissociation: payment for value of members interest and dissolution of the
LLC.
New rule: After we implement the check-the-box rule there was no
need for the old default rule since you dont have to negate continuity-oflife to be taxed like a partnership. Many LLC statutes no longer provide
that member dissociation dissolves the firm.
under Delaware LLC law, theres no concept at all of
dissociation an LLC without a term has perpetual life).
LLC statutes that do have the dissociation concept either dont
provide for dissociation at will or wont allow the dissociating
member to have a buyout.
Holdeman v. Epperson
Facts: Holdeman owns 51% and Epperson owns 49% of a member-managed LLC w/
operating agreement. Holdeman dies and wife becomes executor (successor-in-interest)
operating agreement says s-i-i can only be admitted as member w/ written consent of
company. Epperson says she cant be a member. Wife files suit to declare she be given all the
rights of a member during the estates administration. Epperson argues that Holdeman ceased
to be a member as soon as he died wife is the assignee of his membership interest, but not a
member. (i.e. she only gets economic rights, not member rights)
Issue: Does the operating agreement conflict with the state statute allowing the
executor to his estate to exercise all his rights as a member for the purpose of settling his
estate? (operating agreement clearly doesnt let her be a member w/o Es OK; but agreement
cant conflict with statute).
Holding: Yes. The widow is entitled to exercise her husbands membership rights for
the purpose of settling the estate.
Reasoning: Statute trumps agreement unless the statute specifically says at the end
unless otherwise provided by the operating agreement. If the legislature intended parties to

Business Organizations Book Outline

be able to contract around the death of a member statute they would have included the
language and here they did not.
Dissent: says that the statute really just was intended to clarify the rights of an
executor if the agreement doesnt address it says this statute interferes with contract rights;
should be a default rule, not used in place of an operating agreement. The statute leaves open
what is necessary to settle the estate and gives her a majority interest with which she can
dictate the future course of the company. Suggests that settling the estate be statutorily
defined as only taking those actions necessary to collect, evaluate, and distribute the estate
no more if were going to keep this statute.
In this case the intent of the parties was clear they wanted the surviving member to have
control over new members.
Note 10-1
Some LLC statutes follow the partnership model and exclude managers or members who
dissolved wrongfully from ongoing management, but that doesnt work well in the LLC
context because LLC statutes generally dont make distinctions between wrongful and nonwrongful dissolution. However, parties can put in the operating agreement what is supposed
to happen when members have dissociated but not yet been paid probably the best idea.
Estate or other successor, like other assignees probably shouldnt have management rights
unless admitted as a member but just like dissociated members who have not yet been paid,
there is probably a fiduciary duty owed by continuing members to make disclosures regarding
purchase of the interest.
LLC members may have the agency power to bind the firm as to 3rd parties if the 3rd party has
not been informed of the dissolution.
Courts are continuously trying to balance the needs of the continuing partner vs. the exiting
partner; many statutes allow dissociation without buyout to balance these needs.
B. BUYOUT
Agreement may set forth details of a buyout right by identifying dissociation events that
trigger the buyout and clarify how the buyout price is determined.
Questions to as when drafting a buyout provision:
(1) should the buyout be based on the sale of the leaving partners interest in the firm, or on a
liquidation of the interest by the firm
(2) is the buyout price based on the value of the members interest in the firm ($ if he sold his
interest alone) or the members pro rata share of the assets of the entire firm?
(3) Should valuation issues be addressed by an appraiser? How do you choose one/ what
guidelines do they follow?
(4) Should the parties try to eliminate valuation issues by determining the buyout price with
reference to a specific amount (based on members capital accounts or the firms book value)
(5) to what extent can cash payment of the buyout price be delayed? (firm likely doesnt want
to liquidate assets to pay off exiting member, but exiting member also needs the liquidity)

Business Organizations Book Outline

(6) Whats the remedy for breach of buy-sell?
Valinote v. Ballis (deals with the I cut, you choose mechanism of fixing the buyout price)
Facts: Omnibus has an I cut, you choose buyout provision in which one investor
sets a price on the shares (membership interest), then the other investor decides
whether to buy the first investors interest or sell his own at that price (idea is that
since the price-namer may be forced to buy or sell keeps the person honest). Valinote
and Ballis are the only two investor-members left in Omnibus, Valinote stops
participating in management and asks Ballis to initiate the clause because he wants
out. Nothing in the agreement dictates valuation so Ballis names a price of ($1,581.29) for each 1% interest (-$79,064.25) for each 50% stake. Valinote agrees to
this price and gives Ballis $79,064.25 (basically to take it off his hands, usually
Valinote would get money in a successful business). Valinote had previously made a
loan in that exact amount to Omnibus no money changed hands, just call it even and
Ballis gets all the interest. Omnibus is still losing money after this transaction and
defaults on a prior bank loan of $200k; Valinote says Ballis has to pay my share on
this debt and any other debt but Ballis refuses so Valinote sues.
Issue: Can former members indemnify current members for guarantees made for loans
where a buyout has occurred?
Holding: No.
Reasoning: Valinote tries to argue that the buy-sell procedure so strongly implies that
financial obligations are severed that he has to be able to indemnify Ballis; indemnity
is necessary for departing members because remaining members can then ruin the
business and trigger the guarantees after the departing member leaves and has no
control. Valinote also argues that resignation paragraph explicitly says you arent
absolved of liability but no such clause is in the buyout provision, so only incentive to
do buyout is to get out of liability (here he paid money too)
Court rejects both arguments this isnt enough to justify overriding the principles of
LLCs have to be able to raise capital, saying something is strongly implicit is not
the same as something being explicit. Valinote should have negotiated with the bank to
absolve his guarantee or negotiated with Ballis to assume it. Here, the negative amount
compensated Ballis for giving up the opportunity to seek relief against Valinote as a
fellow member for future guarantees, but doesnt get rid of Valinotes obligation for
old guarantees. Valinote can seek redress against Omnibus for defaulting but no direct
claim against eachother.
RULE: Ballis is protected by a shield of limited liability former members
cannot get out of an obligation without a creditor releasing the debt against you
(but not the firm). Valinote didnt do that and assumed that buyout with Ballis
absolved him of liability.
Decker v. Decker (note case)
Two brothers in a real estate venture have an I cut you choose buyout mechanism that
provides that in a deadlock the parties shall negotiate regarding the purchase or sale of
their interests. Frederick offers to sell to David for $7 mil, way above value, David
accepts but Frederick doesnt do anything else to close the deal and David sues. Trial
court appoints a receiver and has David buyout Fred for 2.5 million. Frederick
appeals.

Business Organizations Book Outline

Court sees that Frederick was attempting to sabotage the agreement and this left
dissolution as the only remedy available under the operating agreement only have to
sell assets, not interests according to the agreement; basically the court says you made
the agreement, not us stick to it. This is the pox on both your houses case b/c both
brothers arent happy with the outcome.
*I cut, you choose provisions work well when the parties are similarly situated
financially, but otherwise invites the wealthier member to take advantage of the poorer
one by naming a price knowing he can pay it and the poor one cant.
C. EXPULSION
An agreement may provide that members may be expelled from the LLC or members
may be expelled by unanimous vote of the other members if its unlawful to carry on
business with the member, there has been a transfer of the members distributional
interest or if the member is a corp or partnership that corp or partnership is dissolved
or not functioning.
Sometimes expulsion requires a judicial order happens when a member has acted
wrongfully adversely affecting the business, willfully and persistently breached the
operating agreement, fiduciary duties or statutory obligations, or has just engaged in
conduct relating to the companys activities which makes it not reasonably practicable
to carry on with the person as a member.
**ULLCA provides that the agreement cannot vary the right to seek judicial order of
expulsion; RULLCA says the agreement cant vary the power of the court to grant
dissolution in those circumstances. BUT in NY, a court refused to order expulsion as a
remedy for breach of fiduciary duty bc remedy wasnt set forth in NYs LLC act.
CCD, L.C. v. Millsap
Millsap had misappropriated a lot of $ from CCD for personal use Newman and
Stanley (other members) a week after finding out telling him his benefits had been
terminated and to file for COBRA insurance coverage, he responds asking about
COBRA. Then Millsap says I cant be terminated as a member because he satisfied all
the elements of reinstatement and that he was eligible to retire from the firm (retaining
his benefits) and wrote a letter to CCD giving his notice of retirement CCD sues
Millsap.
Court rejects Millsaps argument that he retired before they expelled him race to the
courthouse doesnt provide any indication of the merits. By statute in this jurisdiction
the court orders expulsions the court affirms the courts authority to have expelled
Millsap.
10.03: Dissolution
A. General Provisions

Business Organizations Book Outline

Dissolution under ULLCA and RULLCA mimics RUPA and RULPA they set forth
certain evens that trigger dissolution and winding up of the firm. However, Delaware
and RULLCA dont provide for dissolution upon member dissociation b/c of check the
box rule. Even if a statute does, you can contract around it.
B. Oppression and Deadlock
An LLC may be dissolved by a court due to oppression useful when statute or the
agreement restrict members exit and dissolution rights. See Decker v. Decker above
-- court held that the firm could be dissolved for the members oppressive behavior in
sabotaging the buy-sell agreement.
Things are more complicated when there parties are dead-locked without obvious
misconduct.
The standard is generally that the court can grant dissolution of an LLC if it is not
reasonably practicable to carry on the business according to the operating agreement
this standard is examined in Lola Cars
Lola Cars Intl Ltd. v. Krohn Racing, LLC
Facts: the P & D formed an LLC, Proto-Auto to carry on a joint venture;
Hazell (manager of Krohn also served as CEO of Proto-Auto). P & D deadlocked on
whether to remove Hazell as CEO so Lola sued Krohn seeking judical dissolution.
Issue: When is it reasonably practicable to judicially dissolve an LLC?
Holding: Conduct here was sufficient to order a dissolution.
Reasoning: Examine these factors (from Fisk):
(1): whether the members vote is deadlocked the board level (2):
whether theres a mechanism to resolve deadlock in the agreement (3): whether there
is still a business to operate based on the companys financial condition.
None is individually conclusive but give guidance to decide whether the company can
continue in its stated business purpose practically.
(1) Lola and Krohn, themselves are deadlocked (board level) (2) agreement
provides for a buyout mechanism in the event of dispute but its entirely voluntary (3)
Lola claims the business is insolvent because its liabilities exceed its asset (Krohn
says these are mostly loans).
Court says Lola satisfied 2 of 3 elements but have to look at the other facts primary
purpose is to develop and manufacture race cars for sale; lola does the designing and
manufacturing while Krohn tests them and provided Hazell. Agreement doesnt
specify who markets and sells, but reasonable to infer its Hazell as Krohns
contribution. (Hazell has a central role in management). Lola alleges mismanagement
saying Hazell favored Krohns interests Krohn refuses to fire him. Lola also alleges
disloyalty.
Court says that these circumstances make it pretty much impossible to attain
commercial success if Hazell is in fact careless and disloyal. But defendants argue
that the agreement provides for circumstances of termination and judicial dissolution

Business Organizations Book Outline

is NOT among them but court says those provisions are permissive you cant
contract to preclude judicial dissolution as a remedy where it is provided for by
statute.
Case goes to trial on merits where court concluded Hazell had not breached his
contract or violated any fiduciary duty declined to dissolve the LLC (says if plaintiff
had been able to prove the facts alleged it likely wouldve called for dissolution, but
Lola couldnt) Here, it amounted to little more than disappointment in management
cant seek judicial dissolution just to free yourself from a bad deal, if she wants out
still she can invoke the agreements provisions to do so.
(usually mere disagreement isnt enough)
Vila v. BVWebTies LLC (note case)
Bob Vila and Hill co-equal owners and managers of an LLC started to develop bobvila.com.
all decisions required OK of both, but the informal relationship was that Hill ran the LLC
eventually Vilas other shit falls through and he wants back in management of the LLC but he
and Hill disagree on the LLCs direction. Court grants dissolution bc Hill gave himself
unilateral decision-making authority in spite of Vilas objections no alternative for deadlock,
obviously cant continue in conformity with LLC agreement b/c Hill has assumed all the
authority when the agreement calls for both.
In Re. 1545 Ocean Ave. LLC
1545 LLC was formed (50 units to Crown Royal, 50 units to Ocean Suffolk) operating
agreement provided for 2 managers (Houten and King members of Ocean Suffolk and
Crown Royal respectively) each member contributed 50% of capital to buy 1545 ocean ave
(LLC formed to purchase property, rehabilitate existing building and build 2nd building for
commercial rental)
Deadlock results because members werent able to agree on a buyout of each others interest
in 1545 LLC court applies the not reasonably practicable standard, but follows NY case
law that says a disagreement regarding the accounting of the entity is insufficient to warrant
dissolution. Finds dissolution to be a drastic remedy especially in this case because the
construction was still going on seem to be meeting their goals in that realm and the manager
isnt violating the agreement.
In Re Superior Vending, LLC
Plotkin and Tal formed an LLC (Superior vending) but never executed an operating
agreement; the two agree to dissolve but disagree about the distribution of the assets the
court gives Tal his initial investment back and decided that the most equitable solution for
liquidation in this case was to give Plotkin the option to purchase Tals interest allowed Tal
to recover his investment plus a reasonable return w/ respect to interest.
C. Alternatives to Judicial Dissolution

Business Organizations Book Outline

Still question whether parties can wholly draft around judicial dissolution as a remedy, even
without substituting another remedy like arbitration (for example, Delaware emphasizes
partys freedom of contract)
D. Distributions on Dissolution
ULLCA default rule provides distribution first for amounts due for distributions, then
contributions or return of other capital, then profits.
Most other statutes rely on parties own accounting or agreement since most LLCs usually
have one or the other on which to base allocation.
E. Formalities
LLC statutes usually require filings on dissolution and winding up notifies third parties of
the change in the power of members/managers to bind the firm (when filed on dissolution)
filing on termination as well is important because it tolls the statute of limitations for claims.
Note 10-5 Drafting the Operating Agreement
Liquidation procedure specify procedure for electing person to handle winding up, clarify
what may be done during the winding up period (selling assets, deferring sale, distributing
assets in kind, etc.)
Priority distribution agreement can control the distribution of assets in terms of member
priorities amongst themselves (for example in accordance w/ capital account balances)
Type of distribution agreement can govern whether distributions are made in property (in
kind) or cash. Most statutes provide that members dont have to accept and are not entitled to
disproportionate in-kind distributions (many valuation problems).

Business Organizations Book Outline

PART IV FURTHER DEVELOPMENTS IN LIMITED LIABILITY
CHAPTER 11: LIMITED LIABILITY PARTNERSHIPS
11.01 Introduction
11.02 Creation of an LLP
A. LLP Registration Process
1. Formation of the Partnership
LLP statute provides that an LLP is a partnership suggesting that if a firm is not a
partnership then it cannot be an LLP
Conversely, if firm registers as an LLP, it is expressing its intent to be a partnership
2. Vote on Registration
Most LLP statutes provide for registration as an LLP by a vote of the partners
o Although dissenting partners may be able to block the registration by
exercising their statutory power to withdraw and compel liquidation of the
partnership
The partnership agreement may prevent this tactic by penalizing
withdrawal or providing a way for the non-dissenting partners to avoid
liquidation
3. Post-Registration Liability
LLP statutes provide that partners have limited liability from the time of registration,
even as creditors who were not aware of the registration
o By contrast, if the firm had dissolved and reformed as an LLC or corporation,
the partners might be personally liable for post-dissolution transactions to
creditors who were not notified of the change of form
4. Effect on Existing Contracts
Because LLP registration does not cause the underlying partnership to dissolve,
contracts and debts simply continue to bind the LLP unless by their terms they are
expressly subject to an intervening LLP registration
o By contrast, when a partnership dissolves and reforms as an LLC or
corporation, the dissolution might terminate existing contracts, particularly if
these contracts include clause that preclude assignment by merger or sale to a
3rd party, including another business entity
B. Potential Problems of Registration
1. Effect on Dissenting Members
RUPA accommodates the minorities interest by providing for approval of registration
by the vote necessary to amend the agreement
2. Creation of Two Classes of Liabilities
After registration, the firm has at least two classes of creditors
o (1) Creditors who can collect out of the assets both of the firm and the
individual partners, and
Gives partners incentive to pay pre-registration claims for which they
have personal liability, leaving insufficient assets to cover the postregistration claims for which their liability is limited

Business Organizations Book Outline

This also subjects limited liability creditors to an extra risk of a
shortfall of assets
o (2) Those creditors who may not have claims against individual partners
3. Effect on Post-Registration Creditors
Creditors might be able to still attain personal liability of partners if the firm did not
adequately disclose their new LLP status
4. Effect on Existing Contracts and Relationships
While LLP registration continues the pre-existing partnership entity, and the firms
contracts either among partners or between the partnership and third parties remain
unaffected, there are many questions that arise in this situation
o Ex. are post registration loans pursuant to a pre-registration line of credit
subject to the LLP liability limitation?
o Is a partners malpractice covered by the registration if it was committed prior
to registration but results in an injury afterwards?
Creditors can of course deal with these issues in their agreements with the partnership
o The problem though is that older agreements could not have anticipated the
LLP registration
C. Choice of Law
LLP statutes simplify choice of law by applying to foreign LLPs the law of their state
of formation
Like foreign LLC provisions, LLP statutes generally provide that a foreign LLP must
register prior to transacting business in the state
However, the firms formation state law applies even if the firm does not register
o Although, the firm may be unable to sue in the states courts and it may be
served through the secretary of state

11.03 Limited Liability

A. Scope of Limited Liability
The limited partnership cases are distinguishable from registered LLP cases for two
reasons:
o (1) the clear language of the Texas statute provides that partners are protected
from individual liability only for debts and obligations that are incurred while
the partnership is a registered LLP
Expiration under that statute was 1 year unless renewed prior to the
expiration date
o (2) because there is no substantial compliance section, nor does it contain a
grace period for filing a renewal application, a partnership must be in
compliance with the registration requirements for its partners to receive
protection from individual liability
NOTE 11-1
o Should limited liability protect partners from being held personally liable if the
partnership cannot satisfy the judgment of a withdrawing partners share?
The Court in NY held that any debts, obligations, or liabilities refers
only to liabilities to 3rd parties and not among the partners
The reason the partner was given better treatment than 3rd party
creditors is because the statute was intended to deal only with vicarious
liability

Business Organizations Book Outline

The structure of the LLP provisions is as an appendage to the general
partnership statute; it relieves the partners from liability to 3rd party
creditors but leaves the other provisions of the act, including the
liability of partners to each other upon withdrawal, intact
The partners can handle these situations by provisions in the
partnership agreement, however, in this case there were no
provisions in the agreement, so the provisions of partnership
law govern
Texass statute was amended to include protection for obligations of
one partner to another partner, absent an agreement by the partners
otherwise
B. Supervisory and Misconduct Liability
Partners, like other members of limited liability firms, are immune only from vicarious
liability rather than from liability for their own misconduct
LLP statutes generally provide that LLP partners are personally liable not only for
their own misconduct, but also for the conduct of others in which they somehow
participated or for which they had some monitoring responsibility
o This puts liability on the those who are in the best position to prevent the harm
o Thus, supervisory liability ironically may have the result of discouraging law
firms efforts to move toward greater peer review and internal monitoring
Law firms may contract to indemnify or compensate the partners who take the
supervisory risk though
o Problems arise with these contracts though too such as conflicts of interest
between partners, and costly to draft and negotiate
C. Contracting for Liability
One or more partners can contract around the statute and personally guarantee
particular debts of the firm
D. Veil-Piercing
Courts may still apply personal liability on partners of LLPs that have complied with
all statutory formalities, just as they have on corporate shareholders, under a piercing
the veil theory
E. Creditor Enforcement of Partner Liability
Usually a creditor must exhaust all partnership funds to satisfy a debt before turning
to partners personal funds
o However, for a partners liability for his own debts, RUPA excuses exhaustion
if liability is imposed on the partner by law or contract independent of the
existence of the partnership
F. Contribution
Under RUPA, a partner does not have to contribute to the pot to pay off liabilities
for which their liability is limited
Bankruptcy law provides that partners are liable for contribution deficiencies only to
the extent that under applicable non-bankruptcy law such general partner is personally
liable for such deficiency
G. Indemnification
Indemnification is the process by which partners settle responsibilities for liabilities
among themselves

Business Organizations Book Outline

It will operate the same way in an LLP as in a non-LLP partnership unless the
indemnification liability exceeds the partnership assets and thereby raises the issue of
whether partners must contribute to make up the shortfall

Business Organizations Book Outline

Corporations
October 28:
Corporations
Can be public or closely held
Public: characterized by public secondary market in which company
shares are traded.
Closely held: no secondary market for stock; small number of
shareholders who actively participate in management
Critical attributes of corps
Legal personality separate legal existence; legal fiction but
allows a corp to sue and be sued; taxed separately; some
constitutional rights; requirements for formal creation
Limited liability shareholders not personally liable for
acts/debts of the corp unless personally liable by reason of
own acts
Separation of ownership and control: business and affairs
of the corp are managed by its board of directors that is
elected by shareholders.
o Individual board members arent agents, board in its
entirety alone can bind the corp
o A director can also be a shareholder (common in closely
held corps)
o Have to hold meetings w/ recorded minutes; require
quorum
o Shareholders get to vote on election of directors;
amendments to articles of incorp. And by laws;
fundamental transactions
o Rights of shareholders
Voting rights above; receive payments of dividends
when and as declared by the board; distribution
upon termination; preemptive right to purchase
new issuance or corporate stock to maintain
ownership percentage
Right to file a derivative suit to redress wrong
suffered by the corporation (damages belong to
corp)
Liquidity
Flexible capital structure
o Capital structure permanent and long term contingent
claims on the corps assets and future earnings issued
pursuant to formal contractual instruments called
securities may be packaged as stocks or bonds
o Bonds are debt securities and stocks/shares are equity
securities

Business Organizations Book Outline

To form a corp you have to give a name that indicates that you have
limited liability have to deliver articles of incorporation to the secretary
of state for filing. (specify # of shares, address of initial registered office
and the name and address of each incorporator in addition to corp name)
In agreement you have to specify the number of shares the
corporation is authorized to issue (authorized shares) board will have to
involve shareholders if they want to sell more shares than are authorized
or wants to issue a new class of shares.
A state isnt allowed to deny a foreign corporation the right to
incorporate in their state so long as the corp is engaged in interstate
commerce (foreign = another state; alien=another country) Delaware is
a really popular state to incorporate in b/c no minimum capital
requirements, only need one incorporator, favorable franchise tax;
extensive case law; can keep books and records outside of Delaware and a
principal place of business elsewhere other tax breaks too when doing
business outside of Delaware.
OCTOBER 28 Reading
Southern-Gulf Marine Co. v. Camcraft, Inc.
Facts: P & D sign a letter of agreement under which Southern-Gulf
was to purchase a boat from Camcraft; anticipated delivery date so
Camcraft starts purchasing components and states that a definite
contract would be written asap thereafter, the two executed the
Vessel Construction Contract which the defendant defaulted on;
Southern-Gulf sues for specific performance and damages for failure
to timely deliver the boat; defendant responds by arguing that
theres no cause of action because Camcraft was not incorporated at
the time of the contract (wasnt party to the contract)
Issue: Can a now-incorporated entity escape liability for promises
made prior to incorporation?
Holding: Yes. Camcraft dealt with the plaintiff as if a corporation.
Reasoning: both parties would be estopped from denying the
existence or legal validity of the corporation. No indication that
substantial rights of the defendant were affected by the plaintiffs
status as a corp both relied on the contract in financing and
purchasing. Camcraft cant now say you werent a corporation so I
didnt have to perform the contract because Camcraft treated SGM
as a corporation.
RULE: A third party who dealt with the firm as though it were a
corporation and relied on the firm, not the individual defendant, for
performance is estopped.

Business Organizations Book Outline

De dacto corp: courts will treat firm as a corporation if the organizers in
good faith tried to incorporate and had legal right to do so and acted as a
corporation (may not be applied if person is aware of the defective
incorporation)
Estoppel: treat firm as though a corp if the person dealing with the firm
thought it was a corporation all along and would earn a windfall if now
allowed to argue that the firm wasnt a corporation.
Walkovszky v. Carlton
Facts: plaintiff was injured when he was run down by a taxicab
owned by the defendant corp which was allegedly being negligently
operated at the time. Multiple cab corporations each owns like 2 cabs,
seem to be independent but theyre operated as a single entity. Complaint
alleges that the corp is a dummy for individual stockholders to avoid
liability (undercapitalized and underinsured) wants to pierce the
corporate veil to hold individual stockholders liable. Because they arent
acting as a corporation (also says theyre defrauding the public)
Issue: should the corporate veil be pierced in this situation?
Holding: No.
Reasoning: The corporate veil may be pierced where necessary to
prevent fraud or achieve equity where anyone uses control of the
corporation to further his own rather than the corporations interests. Here
the court finds that although the defendant may have been in control of a
fragmented corporate entity, theres no allegation that he was conducting
business in his individual capacity. As for allegations of fraud, its not
fraudulent merely because it consists of multiple corporations.
2 different theories are asserted here: (1) piercing the corporate veil
(2) Enterprise liability: hold all of the individual cab companies and
one large entity have to show that the corporations didnt respect
separate identities comingling accounts, assignments of drivers,
etc.
Sea-Land Services Inc. v. Pepper Source
Facts: Sea Land ships peppers on behalf of Pepper Source, ends up
owing Pepper source a lot of money sues but PS has been dissolved for
failure to pay state franchise tax and apparently had no assets left. As a
last resort Sea-Land brings suit against Marchese and the 5 business
entities he owns (including PS) to pierce the corporate veil to hold
Marchese personally liable then reverse pierce the other corporations to
hold them liable as well. Sea Land attempts this by alleging that all 5
corporations are alter egos of each other manipulated by Marchese to
defraud creditors and for his own personal use.
Issue: Should the corporate veil be pierced in this case to hold
Marchese liable? Should the 5 entities be held as alter egos?
Holding: No.

Business Organizations Book Outline

Reasoning: 2 requirements to pierce the corporate veil (1) unity of
interest and ownership such that the separate personalities of the
corporation and the individual, or other corporation no longer exist; (2)
circumstances must be such that adherence to a separate corporate
existence would sanction fraud or promote injustice.
For prong 1 look at (1) failure to keep corporate records or to comply
with corporate formalities (2) commingling of funds or assets (3)
undercapitalization and (4) one corp treating assets of another as its own.
Application of facts: Marchese is the sole shareholder in 4 of the 5
(50% in 5th) no corporate meetings, no articles of incorporation, runs all of
them out of the same office, same expense accounts. As for $ he borrows
from the corps interest free (court mocks him about this) used the funds to
pay child support and alimony, education for kids, etc. Court says
obviously prong 1 is satisfied. Court says you have to have both prong and
prong 2 and its hard to decide what constitutes injustice on a summary
judgment motion since case law provides for piercing the corporate veil on
prong 2 only when some wrong beyond a creditors inability to collect
would result.
(Examples of wrongs cited in this case common sense rules of
adverse possession would be undermined; former partners would be
permitted to skirt the rules of monetary obligations; unjust enrichment;
intentional scheme to funnel assets into a liability free corp)
Court denies summary judgment tells plaintiff to come up with evidence
to show unjust enrichment of Marchese, that he intended to create these
corps to defraud creditors something like the case law but at this point
its not enough for summary judgment on prong 2.
In re Silicone Gel Breast Implants Products Liability
Facts: MEC manufactured implants, Bristol purchased MECs stock
through a series of mergers MEC is a wholly owned subsidiary of Bristol.
Bristol expands implant business executed in the name of MEC but
negotiated by Bristol and paid from Bristol account. MEC officials dont
recall having meetings, the few adopted resolutions were prepared by
Bristols officials
Plaintiff is asserting claims of both corporate control (pierce the veil) and
direct liability against Bristol for MECs products (you should usually try
both if theres a chance at direct liability)
Holding: denies Bristols motion for summary judgment
Reasoning:
Corporate veil piercing claim:
Parent corp is expected and required to exercise some control over its
subsidiary but when the corp is so controlled as to be the alter ego or
mere instrument of its stockholder, limited liability may not be
guaranteed. Court says a jury, could and probably should find that MEC
and Bristol are alter egos denies Bristols motion for summary judgment.

Business Organizations Book Outline

Factors to look at when control over a subsidiary is at issue for the
purposes of PCV:
Common directors or officers
Common business departments
Consolidated financial statements
Parent finances the subsidiary
Parent cause the incorporation of the subsidiary
Subsidiary operates with grossly inadequate capital
Parent pays the salaries and other expenses of the subsidiary
Subsidiary receives no business except that given to it by the parent
Parent uses subsidiary property as its own
Daily operations are not kept separate
Subsidiary doesnt observe corporate formalities
** IN THIS CASE DELAWARE DOESNT NECESSARILY REQUIRE THE 2ND
PRONG its enough to show that its an alter ego. (but does note the
distinction between tort cases and contract cases)
Direct Liability Claim
Bristols in house attorneys reviewed and approved warnings inserted in
physicians offices that caused the injury court says this could be
undertaking because Bristol allowed their name to be on the pamphlets
seemingly showing their support of the product and to increase confidence
that these types of implants were safe. Court says this is enough to allow
this claim to stay in court denies Bristols motion for summary judgment
on this claim as well.
Fershees Blog You Cant Pierce the Corporate Veil of an LLC
because it doesnt have one
Basically Fershees commenting on a case decision bc he doesnt
like that they treat LLCs the same as corporations and didnt call it
piercing the LLC veil or piercing the veil of limited liability stresses
that LLCs are not corporate entities despite courts continuing to call
them as such theyre a distinct entity. LLCs dont have to adhere to
corporate formalities so cant consider that when deciding when to pierce
the veil unless LLCs have seriously misused the minimal formalities theyre
required to maintain. Some say that piercing the LLC veil should be done
away with entirely but no backing for it says courts need to clear up what
it takes to pierce the LLC veil.
Takeaways: How to avoid personal liability? respect corporate
formalities and take out the minimum insurance (in 90% of cases courts
wont pierce the veil if these are met)
Avoiding enterprise liability is more difficult need separate books and
accounts for each corp, careful accounting of supplies, etc.

Business Organizations Book Outline

Cant pierce the corporate veil? Try direct liability (shareholders own acts
or omissions make him liable for corps liabilities); commercial
misrepresentation; fraudulent transfer; tort claims

October 30th: Business Organizations: CORPORATIONS

Direct vs. Derivative Suits
Direct:
o Brought by shareholders in his or her own name;
o Cause of action belonging to the shareholder in his or her individual capacity;
o Arises from an injury directly to the shareholder.
Derivative:
o Brought by a shareholder on corporations behalf;
o Cause of action belongs to the corporation as an entity;
o Arises out of an injury done to the corporation as an entity.
Traditional Test to see what type of suit:
Who suffered the most direct injury?
o If corporation, suit is derivative.
To whom did the defendants duty run?
o If corporation, suit is derivative.
Classic direct suit: When shareholder is derived of vote. All the shareholders have the
same harm, but it still and individual harm.
Security for expense- as the following case shows, some laws can require the corporation to
pay all the legal expenses in a derivative proceeding. The court can even require the
corporation to put up bond to ensure payment.
Cohen v. Beneficial Industrial Loan Co.
DIVERSITY PROCEEDING: suit filed in federal district court of NJ. Corporation
incorporated in Delaware.
Complaint alleged that the individual defendants were engaged in a conspiracy to enrich
themselves. The stockholder had demanded that corporation institute proceedings to
recover the money, but by their control of the corporation, the individual defendants
prevented them from doing so. The stockholder tried to assert the right of the corporation.
o This stock holder was 1/16,000 stockholders, he woned 100 of its more than two
million shares, so that its holding totaled 0.0125% of the outstanding stock and had
a market value of 9k.
The federal court only had jurisdiction because the parties had diverse citizen ship. So the
question is whether the court must apply a statute of the forum state, which makes the
plaintiff, if unsuccessful, liable for all the fees involved in the litigation.
o NJ has a statute that requires a shareholder owning less than 5% interest to put up
security for the corporations reasonable expenses if the suit fails. Plaintiffs can be
required to post bond to secure such expenses before a suit goes forward.
(Security for expenses statute)

Business Organizations Book Outline

o Neither Delaware Code nor FRCP requires this.

PH: The district court refused to apply the statute because the state enacted that statute
while this matter was pending in federal court.
POLICY CONCERNS: Derivative suits belong to the entity (corporation). Maybe the
corporation didnt sure because there is a good business reason not too. Look for when the
board or CEO reaps personal benefits instead of the corporation benefiting. Derivative
suits can protect against this conflict of interest.
Holding: Statute applies in New Jersey Federal Courts.
o In dealing with Choice of law, the Court looks to Erie Railroad v. Tompkins,
which states that federal law governs procedural issues and state law governs
substantive issues.
o The Court said that the NJ statute was a substantive proceeding because it
created a new liability as well as a condition of standing.
o Here, the plaintiff alleged breach of fiduciary duty, mismanagement, theft, and
waste. A federal court sitting in diversity suits applies the forum state choice of
law. NJ Choice of Law applies law of state of incorporation to substantive merits.
o The Court further says that this law is constitutional because it didnt require
unreasonable repayment and fiduciary cases are susceptible to regulation like this.
Analysis: On one hand, derivative suits allow shareholders to hold directors accountable.
remedy born of stockholder helplessness. However, these suits are often abused in the
form of strike suits (nuisance suits brought for settlement value) and meritorious suits
(suits that are settled too easily).

Bringing Derivative Suits

Plaintiff side incentives:
o Any recovery goes to corporate treasury whether by settlement or trial victory.
o Lawyer is real party in interest.
Lawyer can get contingent fee out of any recovery; BUT Corporation also
must pay plaintiffs legal fees if there is a substantial nonmonetary benefit.
(Courts liberal in finding such benefit).
Defendant incentives:
o Defendants can use strike suits to their advantagesettle to go away.
o Meritorious suitsgo away too quickly sometimes. Corporation must reimburse
the directors expense, so a settlement where the director gets out of paying is
deemed a success.
Combined effect:
o Plaintiffs counsel has inventive to bring strike suits; management has inventive to
pay..
o Management has incentive to settle in ways that ensure indemnification; plaintiff
lawyers have incentive to settle so as to get on to the next casesettled to lightly.
TAKEAWAY: SECURITY FOR EXPENSE STATUTES ONLY ADDRESS STRIKE
SUIT ISSUE.
Standing to bring a derivative suit in federal court:
o Must be a shareholder at the time of the act or omission complained of or became
a shareholder by operation of law from one who was a shareholder at that time.

Business Organizations Book Outline

o Must still be a shareholder when the action commences

o Named plaintiff must be fair and adequate representative of the corporations
interest.
Look for conflicted interests, such as bringing suit for unrelated strategic
purposes.
Unclean hands of the plaintiff.
Plaintiffs filing derivative suits must show any efforts made to receive the outcome they
wanted before filing the suit. Or you must have a legitimate reason why you did not try to
fix it before you came to court.
Court MUST approve all settlement agreements. When deciding to approve/disapprove
settlements, courts consider:
o The max and likely recovery;
o The complexity, expense, and duration of continued litigation;
o The probability of success;
o The stage of the proceedings;
o The ability of the defendants to pay a larger judgment;
o The adequacy of the settlement terms;
o Whether the settlement vindicates important public policies;
o Whether the settlement was approved by disinterested directors;
o Whether other shareholders have objected.

Schoon v. Smith (del. 2008)

Non-stockholfer director said that other directors were breaching fiduciary duties. Didnt
have standing. You must find a shareholder to bring a derivative suit.
Eisenberg v. Flying Tiger Line, Inc. No 8
FJ goes thru a restructuring and merger. E, on behalf of himself and all other stockholders
similarly situated, tries to enjoin this plan. He claims that a series of corporate maneuvers
were used to dilute his voting rights. In the plan, FJs assets go into FTL, and FTX (what
E will own stock in now) is just a holding company. FTL is the operating company. Assets
in FTX are gone. The merger was approved with 2/3-shareholder vote.
He sued in NY. FJ, a Delaware Corporation, with its principal place of business in
California, removed the action to federal court. FJ believed that Eisenberg should have to
comply with NY law which requires a plaintiff suing derivatively to post security for the
corporations cost. The lower court ordered this and gave E 30 days to come up with the
money. When he didnt come up with the money, his claim was dismissed.
The lower court is REVERSED because E suit is personal and not derivative and held
that he should not have had to post a security bond.
ANALYSIS:
o Court looks to Cohen in determining whether he should have been required to post
security for the costs.
Court notes that Cohen showed that the applicability of security statutes
cannot be determined simply by whether substantive or procedural law will
govern.

Business Organizations Book Outline

o Here, the Court must decde whether to apply NY law (holding E liable) or
Delaware law. The law of NY clearly allows foreign corporations doing business
in NY to invoke this law against resident plaintiffs. The Court holds that since NY
courts would invoke itso now law on security for costs rather than Delawares,
they must do the same.
o Delaware looks at derivatives as two prongs. First, who suffered the harm? And
Second, who would receive the benefit of a remedy.
E claims that his harm was loss of boting rights. When he was the owner of
FT, they directed the business. His vote, not votes for a board who appoints
the board of FTL. His vote is less direct now. This is a direct suit because
he has been harmed, not the corporation.
o Even when a shareholder sues on behalf of other shareholders to enjoin a merger,
etc., he is not enforcing a derivative right. It is a direct right available to all
shareholders.
Examples:
#1- ABC Corp entered into a contract with Jane Jonees. Jones breached the contract, but
ABC Corp has not sued her for that breach. May a shareholder of ABC Corp sue her
directly?
o No. Jones owed no duty to the shareholders as such. Jones breach did not injure
the shareholder directly. The recovery would go to ABC. Thus, the shareholder suit
must be brought as a derivative action.
#2- ABC treasurer embezzles all its money and leaves. Shareholder stock is now
worthless. May a shareholder sue the treasurer directly?
o NO. Not enough for a shareholder to allege that challenged conduct resulted in a
drop in the corporations stock market price. Because your loss is derivative of
the corporations loss, only the corporation can sue.
#3- TT was run over by a cab operated by SC Corp. The SC Corp is owned by Sam
Shareholder. TT wants to sue Sam Shareholder because SC Corp lacks the sufficient
moeny and insurance coverage to compensate her (piercing the corporate veil); however,
this is neither a direct or a derivative suit. TRICK QUESTION.
The Demand Doctrine

This is demanding that the board sue a party.

Typically brought by shareholders to the board of directors;
o It must request that the board bring suit on the alleged cause of action;
o Must be sufficiently specific as to apprise the board of the nature of the alleged
cause of action and to evaluate its merits.
o At MINIMUM, a demand must identify the alleged wrongdoers, describe the
factual basis of the wrongful acts adn the harm caused to the corporation, and
request remedial relief.
Must make demand before filing the suit unless its futile to make it.

Derivative Litigation
1. Is it direct or derivative?

Business Organizations Book Outline

If directplaintiff sues.
If derivative, look to demand futility.
o Demand excusedplaintiff sues (SLC cases)
o Demand required
Demand made
If the demand is refused, was the refusal wrong?
o If wrongfully refused, plaintiff sues.
o If properly refused, stop suit.
NOTE: If the demand is required, Plaintiff
almost always ends up here.
Standard employed: reasonable doubt as to
whether the business judgment rule applied to
decision to refuse demand.
Making pre-suit demands puts the plaintiff on
this tract also.
If the demand is not refused, then the BoD sues.
Demand not madedemand can still be excused with reasonable doubt
that the BoD could have properly exercised its independent and
disinterested business judgment when filed. If not, make demand.

RATIONAL PLAINTIFF AND DERIVATIVE SUITS**

Should file the derivative suit before making the demand. Consequences of not making
the demand are trivial if required, slight delay in litigation while you make the demand.
Waiting to make the demand preserves the right to litigate the suit.
Delaware Legal Standard for Demand futility
P must allege particularized facts creating a reasonable doubt that the board is capable of
making a good faith decision on the suit:
1. Majority of board has material or familial interest; or
2. Majority of the board lacks independence (domination and control by
wrongdoers); or
3. Challenged transaction not product of valid exercise of NJR.
Grimes v. Donald
Overview: Plaintiff made a demand on the BoD before the suit was filed. By doing so, he
concede that a demand was required and also prohibits litigation regarding demand excusal.
This means that plaintiff is almost certain to lose.
At issue here is: (1) the difference between a direct and derivative claim; (2) a direct claim
of alleged abdication by a board of directors of its statutory duty; (3) when a pre-suit
demand in a derivative suit is required or excused; and (4) the consequences of demand by
a stockholder and the refusal by the board to act on such demand.
FACTS: Shareholder plaintiff sues the board claiming that they have been negligent in
approving this employment agreement that gave Donald the ability to terminate his
contract rather easily and still entitled him to pay, among other things. He also claims that
the authority granted to Donald violates the by laws and articles of incorporation, thus
they must be voided and arbograted.

Business Organizations Book Outline

Here, the plaintiff stockholder (a) asserted a claim that the directors abdicated their
statutory duty to manage or direct the management of a business and affairs of the
corporation by entering into various employment contracts with the CEO allowing him to
be responsible for the general affairs and allowing the CEO to declare a constructive
termination of the agreement if the board unreasonably interferes with him; and (b)
plaintiffs made a pre-suit demand on the Board to abrogate the agreements, the demand
was refused, and the stockholders sought to assert that the demand was excused.
Court held that the abrogation claim is one that does not fall under the business judgment
rule and cannot be brought derivatively. This deals with the direct effect on the directors
themselves, not the corporation.
The court notes that the due care, waste, and excessive compensation claims can be
brought derivatively since they harm the corporation as a whole.
o The distinction between direct and derivative claims depends on the nature of the
wrong alleged and the relief if any, which could be granted if the plaintiff were to
prevail. Plaintiff must state a claim that is separate from harms suffered by other
shareholders to bring a direct claim.
o Actions that involve the structural relationship between shareholders and
corporations give rise to derivative suits when the corporation suffers or is
threatened with a loss.
Holding: (1) Abrogation claim dismissed; (2) pre-suit demand is not forgotten once it is
denied. Plaintiffs cant make pre-suit demands and then change their minds. This go
against good policy of putting litigation to a rest at some pointgiving defendants peace
of mind.

Special Litigation Committees

Policy Concerns of Derivative Suits:
Derivative suits are a mechanism of managerial accountability; however, there is potential for
bias because directors cant be expected to sue themselves.
CoA belongs to corporation and litigation is under BoD control. Shareholders may have inters
that are diverse to the corporation. Therefore, BoD should have some say.
It is argued that derivative actions infringe upon the discretion of corporate boards. Thus,
courts should closely look at these suits because theyre essentially getting involved in
managerial affairs.
The conflict of interest issue became a serious concern. (especially in Marks). So the demand
requirement helped filter out these conflicts. The filter basically allows shareholders to prove
that theyre challenging a transaction and not going directly to the board because the board
could not possibly act under the business judgment rule in deciding on the issue.
Board of Directors can appoint special committees to investigate matters if they feel that
theyre not able to make a decision without bias. When examining SLCs courts look to the
disinterested parties because they must be wholly disinterested and also look the application
of their inquiry.
In Re Oracle Corp. Derivative Litigation

Business Organizations Book Outline

Special Litigation Committee used here.

Allegations that Oracle directors engaged in insider trading while in possession of
material, non public, showing that Oracle would not meet the earnings guidance it gave to
the market for the third quarter of the fiscal year. The SLC recommended that the
dismissal of the derivative action after exhaustive investigation and a lengthy report.
The company appointed a SLC composed of two of the board members. (Both Stanford
professors). Among the people accused of insider trading was another Stanford professor
who taught and role-modeled one of the SLC members; a Stanford alumus who donated
millions of dollars to Stanford; and Oracles CEO who had made millions in donations
through a personal fund.
It is the law the SLCs must prove they are (1) independent; (2) disinterested; (3)
conducted a good faith investigation; and (4) conclusion had a reasonable basis.
o The Court doesnt see a faulty investigation, rather they note that the SLC
conducted an extensive investigation.
o The Court doesnt see how the SLC (although they claim to be) could act
independently. All of the ties between the members give reasonable doubt that they
wouldnt. Therefore the burden is on the members to prove they acted disinterested
and independent and here they did not.
The factors they put forth to prove independence are as follows:
Two of the SLC members didnt receive compensation from Oracle
other than as directors;
Neither Grundfest nor Garcia-Molina were on the Oracle board at
the time of the alleged wrong doing;
Both were willing to return their compensation as SLC members if
necessary;
Absence of any other material ties between all the parties (Oracle,
Trading Defendants, Stanford)
However, Defendant Boskin was a Stanford professor, thus there were
undisclosed ties between the board members and the defendant.
SLC members were aware that one of the defendants had made substantial
donations to Stanford.

NOVEMBER 4th Reading

NOVEMBER 4 Reading
A.P. Smith MFG. Co. v Barlow
Plaintiff corp voted to make a donation of $1,500 to Princeton University
defendant stockholders challenged the proposed gift b/c they hadnt
authorized it and wasnt in corps certificate of incorporation (state statute
passed after incorporation allows corps to make donations to charities but
defendants say it doesnt apply to this corp). Corp. files a declaratory
judgment action. Issue is whether plaintiff corp can make donations
without authorization from stockholders or through certificate of
incorporation.

Business Organizations Book Outline

Court rejects the statute argument continuity of life in corps make it
obvious that corps will live under many different sets of laws not just the
ones in effect at time of incorporation. As to donation plaintiff can give $
so long as it didnt exceed max of 1% of capital and surplus AND the
institution receiving the money doesnt own more than 10% in corps
stock. Public policy should encourage gift giving and corporate gift giving
increases the goodwill of the corporation.
Under common law there may be a requirement that the donation benefit
the corporation, but its unclear
Dodge v. Ford Motor Company
Ford is manufacturing a ton of cars priced at $900 but price gradually ends
up at $360 and Ford admits that it lowered the price to expand his
corporation to reach more people even though it negatively impacts profits
basically tells shareholders Ive already made you a ton of money, be
happy with what you have gotten up to this point and will get moving
forward just didnt want to pay out as much in dividends.
Issue: can shareholders force defendant to increase the cost of the
product and limit money put toward expansion to pay out a larger
dividend?
Holding: Court wont force Ford to increase the cost of the product
(falls under BJR) but does say that the shareholders are entitled to a more
equitable-sized dividend because the purpose of a corporation is to make
money for its shareholders and ford is arbitrarily refusing to distribute
funds court allows interest to be applied to shareholders dividends
However general rule to remember is that courts will usually
defer to judgment of directors in issuing dividends but will
intervene if refusal to pay amounts to such an abuse of discretion
to constitute fraud or a breach of good faith.
Shlensky v. Wrigley
Shlensky is a minority stockholder in the Cubs brings derivative suit
agains the owners and the corp. for negligence and mismanagement;
Wrigley was majority stockholder (80%) refused to install lights like every
other stadium had (Shlensky wants to be able to play night games to make
more $) Wrigleys insistence that baseball was a daytime sport and
refused to install lights (other board members agreed to keep his demand
despite economic consequences)
Issue: does a stockholder have a valid cause of action in a derivative suit
where the only allegation is that the conduct is contrary to the best
interests of the corp.?
Holding: No BJR protects this decision.
Prime example of court reluctance to second-guess business decisions
here the court says youve basically just given us statistics that other

Business Organizations Book Outline

teams make more money and want us to extrapolate that its due entirely
to lack of lights/availability of night games, the court wont substitute its
judgment for the directors absent fraud, illegality, or conflict of interest.
Wrigley doesnt have to prove that the decision actually benefits the corp.
just that there could be rational reasons why the directors made the
decision not to install lights (neighborhood affected by installation for
example)
Kamin v. American Express
American Express bought stock for nearly $30 million, now its valued at
$4 million directors decide to give the shares of stock to the shareholders
as a special dividend. Kamin demanded that American Express sell the
stock on the open market and use the $26 million capital gains loss to
offset other capital gains (would save the corp $8 million in the long run)
American express decides not to do that because would adversely affect
American Express stock. Plaintiffs challenge the business decision in a
derivative suit. The court says this is covered by the business judgment
rule no evidence of fraud or other dishonest dealing (aside from 4 of 20
directors benefiting from the decision not enough). The decision to
declare dividends may be unwise but it is outside the scrutiny of the court
Smith v. Van Gorkom
Famous decision by Delaware Supreme Court shocked the corporate
world. Trans Union (Van Gorkom CEO) was convinced that TUs stock was
undervalued and without consulting board of directors suggested to
Pritzker a $55/share cash out merger with a Pritzker company Pritzker
made the $55/share offer (stock had traded at prices ranging from $24$39) but had a 3 day acceptance period. Van Gorkom calls board meeting
and tells them about the proposed transaction an hour before the board
meeting the reaction was negative. At the end of the 2 hr. meeting the
directors approved the transaction neither read it before they signed it.
Court says this decision wasnt covered by the BJR because directors didnt
adequately inform themselves as to Van Gorkoms role in forcing the sale/
establishing the price (2) were uninformed about the intrinsic value of the
company and (3) were grossly negligent in approving sale after only two
hours consideration w/o notice and in absence of emergency/crisis. Court
rejects the argument that the price being high above market value
justified their decision says that no valuation study or other justification
for the price was prepared or requested. Directors respond by saying we
didnt need to do that because they were allowed to take competing offers
for 90 days thereafter to see its worth (but didnt read the agreement
they signed a definitive agreement that didnt allow for competing
offers). Sets up the standard of gross negligence

Business Organizations Book Outline

Takeaways: Reconciling the duty of care and the BJR (directors have a
duty not to be negligent, but the BJR insulates them from negligence
liability allowing liability only in cases of fraud and self-dealing) -- it really
comes down to maintaining a standard of conduct (you should aspire to be
a good director) vs. standards of liability (deciding what would get you into
legal trouble)
NOVEMBER 6th Material
November 6 Material
Francis v. United Jersey Bank
o Issue: whether a corporate director is personally liable in negligence for the
failure to prevent the misappropriation of trust funds by other directors who
were also officers and shareholders of the corporation
o Sons had taken over the family corporation and began to siphon off funds by
making withdrawals entitled loans
The father had done this same thing when he was in charge, but he paid
everything back at the end of the year so it was legitimate although a
woefully inadequate and highly dangerous bookkeeping system
o Plaintiff must establish not only a breach of duty, but in addition that the
performance by the director of her duty would have avoided loss, and the
amount of the resulting loss.
o Courts found that Mrs. Pritchard, the corporate director was personally liable
in negligence for the losses caused by the wrongdoing of her sons, other
directors and officers of the corporation
o Two significant reasons for holding Mrs. Pritchard liable:
(1) she did not resign until just before the bankruptcy
(2) the nature of the reinsurance business distinguishes it from most
other commercial activities in that reinsurance brokers are encumbered
by fiduciary duties owed to third parties
o Directors cannot shut their eyes to corporate misconduct and then claim
because they didnt see the misconduct, they did not have a duty to look
o Because her neglect was a proximate cause in aiding the sons to
misappropriate funds, she was held liable
Bayer v. Beran
o Two causes of action:
(1) charges directors with negligence, waste, and improvidence in a
radio advertising contract beginning in 1942 and costing about
$1,000,000 a year
Would have been dismissed on summary judgment because it
fell under the business judgment rule
o However, the president of the companys wife was
featured in the radio campaign so the court says they
must look at the facts more closely
The Court found that while the wifes participation in the radio
program may have enhanced her prestige as a singer is no
ground for subjecting the directors to liability, as long as the

Business Organizations Book Outline

advertising served a legitimate and a useful corporate purpose

and the company received the full benefit therof
(2) Dr. Henri Dreyfus rendered no services to the corporation under the
employment contract dated 10/2/33 and that whatever services he did
render under the contract; he was already legally bound to performd,
under the sales contract entered into by him and his brother, Dr.
Camille Dreyfus, with the corporation.
Essentially was there any consideration for the joint payment to
the Doctors Dreyfus of $60,000 a year
o There can only be one answer to that question, and that
is that there was full and adequate consideration for the
join remuneration provided.
o Would have been foolish by the directors not to renew
the contracts with both doctors because they were two of
the best chemists in the world
o Both causes of action are dismissed on the merits because the directors acted in
the free exercise of their honest business judgment and their conduct in the
transactions challenged did not constitute negligence, wasted or improvidence
Broz v. Cellular Information Systems, Inc.
o Holding:
Although a corporate director may be shielded from liability by
offering to the corporation an opportunity which has come the director
independently and individually, the failure of the director to present the
opportunity does not necessarily result in the improper usurpation of a
corporate employee
If the corporation is a target or potential target of an acquisition by
another company which has an interest and ability to entertain the
opportunity, the director of the target company does not have a
fiduciary duty to present the opportunity to the target company
o The conduct before the Court involves the purchase by Broz of a cellular
telephone service license for the benefit of RFBC
o CIS brought an action against Broz and RFBC for equitable relief, contending
that the purchase of this license by Broz constituted a usurpation of a corporate
opportunity properly belonging to CIS, irrespective of whether or not CIS was
interested in the Michigan-2 opportunity at the time it was offered to Broz
o Corporate opportunity is fact-intensive and turns on the ability of the
corporation to make use of the opportunity and the companys intent to do so
It was found CIS had just come out of Chapter 11 proceedings and
would have been unable to purchase the Michigan-2 without the
approval of its creditors
CIS CEO had explicitly told Broz that CIS was not interested in
acquiring Michigan-2
After commencement of the PriCellular tender offer to purchase CIS,
Broz contacted another CIS director who also told him CIS had neither
the wherewithal nor the inclination to purchase Michigan-2

Business Organizations Book Outline

Another CIS director also agreed to represent RFBC in dealings with
Mackinac on the acquisition of Michigan-2 where he reiterated CIS
stance that it was not at all interested in the transaction
o The Corporate Opportunity Doctrine holds that a corporate officer or director
may NOT take a business opportunity for his own IF:
(1) the corporation is financially able to exploit the opportunity;
(2) the opportunity is within the corporations line of business;
(3) the corporation has an interest or expectancy in the opportunity;
AND
By taking the opportunity for his own, the corporate fiduciary will
thereby be placed in a position inimicable to his duties to the
corporation
o The corporate director or officer MAY take a corporate opportunity IF:
(1) the opportunity is presented to the director or officer in his
individual and not his corporate capacity;
(2) the opportunity is not essential to the corporation;
(3) the corporation holds no interest or expectancy in the opportunity;
AND
(4) the director or officer has not wrongfully employed the resources of
the corporation in pursuing or exploiting the opportunity
o No one factor is dispositive and all factors must be taken into account insofar
as they are applicable
o What matters is the opportunity depends on the circumstances existing at the
time it presented itself to Broz without regard to subsequent events
This is why he did not have to consider the interests of PriCellular, they
had not acquired CIS yet
Sinclair Oil Corporation v. Levien
o Derivative suit for damages sustained by Sinclair subsidiary
o Chancery court held that because of Sinclairs fiduciary duty and its control
over Sinven, its relationship with Sinven must meet the test of intrinsic fairness
which involves both a high degree of fairness and a shift in the burden of proof
to Sinclair
o Sinclair argues that the transactions between it and Sinven should be test by the
business judgment rule, under which a court will not interfere with the
judgment of a board of directors unless there is a showing of gross and
palpable overreaching
o Court holds that in a situation that involves a parent and a subsidiary, with the
parent controlling the transaction and fixing the terms, the test of intrinsic
fairness, with its resulting shifting of the burden of proof, is applied
o Self-dealing is topic of issue here and occurs when the parent, by virtue of its
domination of the subsidiary, causes the subsidiary to act in such a way that the
parent receives something from the subsidiary to the exclusion of, and
detriment to, the minority stockholders of the subsidiary
o Sinven argues that Sinclair caused them to payout such excessive dividends
that the industrial development of Sinven was effectively prevented and it
became in reality a corporation in dissolution

Business Organizations Book Outline

Sinven attacks these dividends on the ground that they resulted from an
improper motive Sinclairs need for cash (considering they held 97%
of Sinvens outstanding shares)
The Court held the Chancellor erred in applying the intrinsic fairness test to the
dividend payments because they were not self-dealing and the business
judgment standard should have been applied
The dividends might have resulted in a huge transfer of cash to Sinclair,
but a proportionate share of the dividend was received by the minority
shareholders of Sinven as well, son Sinclair did not receive anything
from Sinven to the exclusion of its minority shareholders
The Court then held that the dividend payments complied with the business
judgment standard based on the facts.
The motives for causing the declaration of dividends are immaterial
unless the plaintiff can show that the dividend payments resulted from
improper motives and amounted to waste
The plaintiff contends only that the dividend payments drained Sinven of cash
to such an extent that it was prevented from expanding
However, Sinven offers no evidence of opportunities which came to
Sinven
Therefore, Sinclair usurped no business opportunity belonging to
Sinven
Sinven also sued for breach of contract by Sinclair for purchases of Sinven
crude oil through Sinclair Oil Company (International) because it payments
lagged as much as 30 days although they were supposed to be made at receipt,
and there were fixed minimum and maximum quantities that International did
not comply with
The Court held Sinclairs act of contracting with its dominated
subsidiary was self-dealing and Sinclair breached the contract with
Sinven in regards to both time of payment and the amounts purchased
The contract breach was evaluated under the intrinsic fairness standard
Sinclair failed to meet its burden of proving that its causing
Sinven not to enforce the contract was intrinsically fair to its
minority shareholders