Business Entities Outline

• A) Duty of loyalty: The duty of loyalty mandates that the best interest of the corporation and its shareholders takes precedence over any interest possessed by a director, officer, or controlling shareholder o i) Self-Dealing: Any time a corporation is in a transaction where a director, officer, or majority shareholder is on the other side, and the corporation is exchanging too much for what it is receiving; such a transaction is not invalid unless unfair to the corporation at the time of the transaction (Tomaino) o ii) Usurpation of Corporate Opportunity:

When a director or officer takes a business deal for herself when the corporation would have accepted it. 3 Tests/Elements for Corporate Opportunity: • 1) Line of business test • Actor knows the opportunity is a business activity closely related to a business in which the corporation is engaged or expects to engage. • 2) Expectancy test • Whether offeror expects opportunity will be offered to the corporation or whether a corporation would expect to have an interest in opportunity. This is a narrower test than the line of business test and uses the reasonableness standard. • 3) Financial capacity of corporation • Not whether a corporation would have taken opportunity, but if it could have taken it.

A large company has many types of ways to get capital if it wants to, so unless it’s on the verge of bankruptcy, they have a good argument that it could have had the capacity • If the opportunity meets all of these elements/tests, then there is an implied requirement that the director/officer disclose the opportunity to the board • Can cleanse the usurpation by having a majority of disinterested directors/shares vote in favor of it o iii) Good Faith:

A director cannot act loyally towards the corporation unless she acts in the good faith belief that her actions are in the corporation’s best interest; cannot be the only basis of a duty of loyalty claim. Examples of acting without good faith (Stone): ? Where the fiduciary intentionally acts with a purpose other than that of advancing the best interests of the corporation ? Where the fiduciary acts with the intent to violate applicable positive law ? Where the fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.

• In order to establish director oversight liability (Stone): (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention (both require a showing that the directors knew that they were not discharging their duties • Adopted from Caremark, this means that to establish oversight liability, there must be a systematic failure of the board to exercise oversight duties (tough standard for plaintiffs to show) • B) Duty of Care:

1) director act in good faith, 2) in manner he reasonably believes to be in the best interests of the corporation, and 3) with such care as a ordinarily prudent person in a like position would use under similar circumstances (Crown); it is the duty of the directors of a company is to act on an informed basis, meaning all material information that is reasonably available to them; usually a unitary standard, but court may impose a higher standard for those that have specialized skills/knowledge ?

i) Failure to Inform: The board must exercise a good faith judgment that every corporate act is made with adequate information to assure that decisions are made in the best interest of the corporation; imposes a gross negligence standard • DGCL §141(e) says a director shall be fully protected in relying in good faith upon the records of the corporation and upon such information, opinions, reports or statements by any of the officers, employees, committees, or any other person the director reasonably believes are within her professional or expert competence and who has been selected with reasonable care by or on behalf of the corporation (Crown) o However, the board must question, not blindly rely, on the reports.

o Report must be germane to the subject matter • The question of whether fully informed turns on the fairness and completeness the directors investigation and what they made their decision on • Directors need all reasonably available facts germane to the transaction at issue in an atmosphere of complete candor (Van Gorkum) o Factors used by court: short time limit in meeting, didn’t properly value the company, relied on superficial reports, failing to seek consultation ? ii) Waste: transaction is “an exchange that is so one sided that no business person or ordinary, sound judgment could conclude that the corporation has received adequate consideration” (Eisner)

• This is judged on a rationality standard (NCS) – i. e. did this decision have any rational business justification? • Won’t be considered waste if there was any substantial consideration ? In Delaware, the Board may put into the Articles of Incorporation an exculpating provision that shields any director from liability for a duty of care claim (§102(b)(7)) • 2) Derivative Analysis (Typically, 2 parts).

o If injury is personal/contractual (voting rights, forced payment of dividend, disclosure to meet securities laws), then move on to next step o If alleging a harm to the corporation (breach of fiduciary duty), then must do demand analysis o A) Demand analysis: look at the composition of the board; if you make a demand when you don’t need to in Delaware, you have waived futility argument; if you make demand, you are conceding that the board has capacity to make proper decision, meaning that its decision to not pursue plaintiff’s claim is protected by business judgment rule; you must argue that demand would be futile since you can’t trust the board to make a decision; do this by showing: ?

i) Majority of directors are interested: • When director personally receives a benefit • as a result from the challenge transaction • which is not generally shared with the other shareholders of his corporation and • that benefit or detriment is of such subjective material significance to that particular director that it is reasonable to question whether that director objectively considered the advisability of the challenged transaction to the corporation and its shareholders.

• Even if person doesn’t stand to personally benefit, but it would be reasonable to expect that person to be compromised by nature of their relationship with someone interested, that director will be deemed interested (Shapiro) ? ii) not independent • Independence involves an inquiry over whether the decision resulted from being controlled by another. Controlled if she is dominated by other party by either close personal/familial relationship or through force of will ?

iii) or decision was not a valid exercise of business judgment (waste) o B) Special Litigation Committee (SLCs) Analysis: Whenever a board realizes they are subject to suit, they will immediately compose a SLC of people with nothing at stake in the complained transaction. ? In Delaware, SLC’s have the power to cause dismissal of derivative actions, so long as they can make an untainted decision, but subject to stricter than usual judicial review, where the actual substance of the committee’s decision is evaluated ? Decision of SLC must pass Zapata two-part test: • (1) Did the SLC act independently, in good faith, and conduct a reasonable investigation (w/ the burden of proof on the Ds) • (2) Does the motion to dismiss pass an independent judicial inquiry into the business judgment of the SLC?

? If demand excused, the board is given no deference since the board itself not considered trustworthy; if demand not excused, and SLC makes decision to not pursue plaintiff’s claim, then SLC’s decision protected by the business judgment presumption • 3) Business Judgment Rule (BRJ) Analysis: The BRJ is a presumption that in making a business decision, the directors acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the corporation.

o This presumption attaches to a director-approved transaction within the board’s conferred or apparent authority. o Plaintiff must rebut this presumption with both duty of loyalty and duty of care claims with particular facts that show reasonable doubt as to whether the board breached said duties ? Duty of Loyalty (Orman) • 1) Majority of board lack independence (see above) • 2) Majority of board are interested (see above) • 3) If good faith claim: o Rebut by showing an utter failure to monitor (Stone), meaning no mechanism is in place at all ? Duty of Care• 1) Failure to inform (gross negligence standard – Van Gorkum).

• 2) Waste (irrationality standard, see above – Eisner) • 4) Entire Fairness Analysis: Directors will be found to have acted with entire fairness when they demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain (really only applicable to loyalty claims) o Burden is on the defendant now to show that despite problems, the actions/decisions of the board are entirely fair o Analyzed under the totality of the circumstances – the court can focus on one factor over the other as it deems appropriate o Usually only for duty of loyalty cases, since those are not dealing with dishonesty o Elements to show fairness ?

A) Fair price: examines the price/cost of the actions; plaintiff must be able to show damages here; relates to economic and financial considerations of the proposed merger, including assets, market value, earnings, value of the stock ? B) Fair dealing: examines the procedures for the actions/decisions (i. e. composition of the decision makers, where information came from, how negotiations took place, amount of time spent in making decision, etc. ) ?

C) Miscellaneous “Cleansing actions”: • i) Majority of disinterested board members voted in favor of action/decision (ratification), after full disclosure to the board; so long as you have a quorum of disinterested directors, a majority of that valid quorum can sanitize the transaction (DGCL §144(a)(1)) • ii) Majority of shares voted in favor of action/decision, after full disclosure to the shareholders (DGCL §144(a)(2)) – Statute does not require the shares to be disinterested (qualified) o If defendant successful in showing entire fairness, it does not create a safe harbor, but only revives the business judgment rule and shifts the burden back to the plaintiff to rebut ?

Ex. Plaintiff can rebut if he can demonstrate that disinterested shareholders not fully informed in making decision (Van Gorkum) • MBCA • 1) Nature of Breach o A) Duty of Loyalty: Each director, when discharging her duties, shall act (1) in good faith, and (2) in a manner the director reasonably believes to be in the best interests of the corporation (§8. 30) ?

i) Self-Dealing: Any time a corporation is in a transaction where a director, officer, or majority shareholder is on the other side, and the corporation is exchanging too much for what it is receiving; such a transaction is not invalid unless unfair to the corporation at the time of the transaction (Tomaino) ? ii) Usurpation of a Corporate Opportunity: When a director or officer takes a business deal for herself when the corporation would have accepted it • Corporate Opportunity: Under ALI standard, what is a corporate opportunity depends on whether person is a director or officer o If director: ?

A corporate opportunity only if 1) a corporation would expect to have an interest in opportunity o If officer: ? A corporate opportunity if 1) a corporation would expect to have an interest in opportunity; or 2) the opportunity is a business activity closely related to a business in which the corporation is engaged or expects to engage.?

Harris: Plaintiff has burden of showing that defendant officer-director failed to offer opportunity to board first; defendant must then show that she did offer, it rejected or the transaction was fair to the corporation • To be a corporate opportunity, the director/officer must learn of the opportunity either (1) when performing a specific duty or (2) when using corporate information or property, so not in social situations. • If a corporate opportunity: o i) The director/officer must first offer the opportunity to the corporation o ii) Make a full disclosure concerning the conflict of interest. o iii) The opportunity must then be rejected by the corporation and the rejection must be fair.

• Can cleanse the usurpation by having a majority of disinterested directors/shares vote in favor of it o B) Duty of Care: The directors, when becoming informed in connection with their decision-making or oversight function, shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances when becoming informed (§8. 30(a)) ? i)

Failure to monitor ? ii) Failure to inform (gross negligence) • §8. 30(c) the director is entitled to rely on the performance of persons specified to whom the board may have delegated the authority or duty to perform one or more of the board’s delegable functions • §8. 30(d) the director is entitled to rely on information, opinion, reports, or statements, prepared or presented by persons in (e) • §8. 30(e)(1) one or more other officers or employees that the director reasonably believes to be competent and reliable, and (2) legal counsel, or other experts retained by the corporation, (3) a committee that merits confidence.

? iii)Waste (irrationality) • 2) Derivative Analysis (Typically, 2 parts) o If injury is personal/contractual (voting rights, forced payment of dividend, disclosure to meet securities laws), then move to next step. o If alleging a harm to the corporation (breach of fiduciary duty), then must make a demand on the board to pursue claim o A) Universal Demand Rule: MBCA uses “universal demand” rule, meaning there is no futility analysis since a derivative plaintiff must always demand that the board pursue the litigation ? When the board refuses (almost always), then the plaintiff just moves forward because no business presumption in favor of board’s refusal at this point.

o B) SLC Analysis: Whenever a board realizes they are subject to suit, they will immediately compose a SLC of people with nothing at stake in the complained transaction ? In MBCA jurisdiction, the court will defer more to the decision of the SLC more than in Delaware ? Virtually no substantive evaluation of the decision itself, only in the procedures that led to it (relying on reasonable sources, good investigation, took time in making decision) ? MBCA uses NY rule (PGE & G Shareholder) • Court’s review of SLC decision limited to 1) the independence and disinterestedness of the committee and 2) the appropriateness of the procedures used in reaching its decision. • Essentially, a court under the MBCA will apply the business judgment presumption to the SLC’s decision ?

Plaintiff entitled to limited discovery only as to what the directors took to inform themselves • 3) BJR Analysis: The BJR is a presumption that in making a business decision, the directors acted on an informed basis, in good faith, and in the honest belief that the action taken was in the best interests of the corporation. o This presumption attaches to a director-approved transaction within the board’s conferred or apparent authority o Not exactly present in MBCA, but §§8. 60-33 incorporate same concepts as in Delaware o Plaintiff must rebut this presumption with both duty of loyalty and duty of care claims with particular facts that show reasonable doubt as to whether the board breached said duties ? Duty of Loyalty • 1) Majority of board lacked independence • 2) Majority of board were interested ? Duty of Care.

• 1) Failure to inform (gross negligence standard – Van Gorkum) • 2) Waste (irrationality standard, see above – Eisner) • 3) An utter failure to monitor (Stone), meaning no mechanism is in place at all • 4) Entire Fairness Analysis: Directors will be found to have acted with entire fairness when they demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain (really applicable only to loyalty claims) o Burden is on the defendant now to show that despite problems, the actions/decisions of the board are entirely fair o Usually only for duty of loyalty cases, since those are not dealing with dishonesty o Cleansing mechanisms: MBCA has a real safe harbor, unlike Delaware, meaning that if the defense can show these cleansing actions, it ends the suit (§8. 61(b): ?

A) Show approval by disinterested directors, after full disclosure to the board (§1. 43) ? B) Show approval by majority qualified shareholders (not interested/tainted), after full disclosure (§8. 63) – unlike Delaware, these shares have to be uninterested ? C) Fair to the corporation • Fair Dealing (see above) • Fair Price (see above) AGENCY o Analysis: ? Has an agency relationship been created? ? What kind? ? What are the consequences in terms of liability? o Is there an agency relationship? P hires A who deals with 3rd parties, either in tort or contract. ? Definition P (principal) consents that the A (agent) shall act on the P’s behalf, subject to the P’s control, and the A consents.

• R (3rd) of Agency: Agency is the fiduciary relationship that arises when a principal manifests assent to an agent that the agent shall act on the P’s behalf and subject to the P’s control, and the A manifests asset or otherwise consents so to act. ? Elements: • Mutual consent of both parties to the relationship • Agent acts for the principal • Principal has some control over the agent ? Scope Particular scope, determined by the P’s manifestations. ? Duties An agent’s duties toward the principal are: • Contractual duties (comply with contract) • Agent becomes a fiduciary of the principal. o Duty of care and skill (duty to act according to local standard of care – not to “shirk” on the job – negligence) o Duty of loyalty (duty to act solely for benefit of P) • Agents actions may create liability for P o May bind P in contract o A’s actions may make P liable for tort liability ? Intent.

May be unintended / cannot disclaim the relationship / cannot contract around agency law ? Who are Agents? • All employees • Some independent contractors, • All corporate officers (president or CFO), • But not directors (qua directors), because all corporate power is vested in the board of directors. Their power is collective, so because no one director may act alone, none are individually agents either. • Binding the Principal: Tort v. Contractual Liability o Employees can bind Employer (principal) in contract and tort o Only some independent contractors are agents who can bind the principal in contract only. ? Creation of the Agency Relationship.

• When vague: determined by meeting definition, and amt of control being exercised by principal o whether a principal can be bound by the agent – degree of P’s control o whether a principal can be taken advantage of by the agent – degree of risk to P o whether the agent can act w/o requiring approval by principal (H&R Block) • Basile v. H&R Block (91) o Facts: H&R Block offered two different types of refunds. Unknown to the customers, though, was that H&R was getting a kickback for using the third party (TP). Customers claim that agency relationship. If H&R were acting as the agent, the law would require that they disclose this kickback to the Ps under the fiduciary duty of loyalty. o Issue: Whether the parties created an agency relationship, by deciding whether the customer exercises control over H&R.

o Rules: As an agent you have fiduciary duties of loyalty and care. ? Does the petitioner have control over the agent? • This is the problem prong ? Majority says H&R only offered customers the opportunity to file their tax returns with three options, only one of which involved the loan. Customers themselves decided to take the loan, instead of H&R, so customers did not control H&R. ? Dissent says that the customers controlled H&R because they supplied info and directing H&R to prepare the taxes. Thus, control is present to be an agent with fiduciary duties. o Four Kinds of Agency Authority to Make Agreements to Bind Principal ? Actual authority:

A P is bound to TPs by anything the A does that is in accordance with P’s manifestation to the agent. P’s manifestation is determined by the A’s reasonable interpretation in light of all the circumstances. • (For EXAM answer, actual better than apparent, and express better than implied) (If actual authority, then some degree of express authority at some level) • Two types: o Express actual authority Express manifestations of authority ? Ex. You may sell my car for $2,000. o Implied actual authority Authority could be implied if agent has authority to do collateral acts that are: ? Reasonable & incidental acts • Ex. you are an agent for purchasing Blackacre, an implied authority is that you can go visit the property. • Ex.

If agent to sell, then implied authority to advertise ? Business custom ? Title or position • Ex. if President of corporation, we presume you can do the kinds of things Presidents usually do ? (For EXAM answer, if you argue implied, then also argue apparent authority) ? Apparent Authority Apparent authority stems from a third party’s reasonable belief, traceable to the P’s manifestation that the A is authorized to act for the P. • P is bound by an A’s actions within the scope of the A’s apparent authority, too. • Possible to have this kind of authority without intending it. • Express o Ex. Still party may think you are still the agent of the principal.

If P has cancelled the express agency by firing the A, then no actual authority. But the TP does not know that. Will the P be bound to that contract? Yes, b/c P is in the best position to avoid this kind of fraud and protect TPs. • Implied o Reasonable & incidental acts o Business custom o Title or position • In the Matter of McDuffie (96) – Apparent Authority o If the third party is justified in believing that the agent is acting with the authority from the principal, then the principal will be held liable for the agent’s actions. ? Ratification When action fails to bind P, P may approve of actions after the fact: • Expressly, or • By conduct demonstrating intent, such as.

o Retention of benefits (strongest argument) o Failure to repudiate o Acceptance • Unless TP withdraws prior to P’s ratification. ? Estoppel P who has neither authorized nor apparently authorized an agent’s action is nevertheless liable to TPs who have changed their position in reliance upon their belief that the action was authorized if the P caused (intentionally or carelessly) the belief or, if the P, knowing of the belief, did nothing to notify the TP of the facts. • Elements o Justifiable, detrimental reliance, and o Either: ? Negligence by P, or ? Knowledge by P and failure to correct • Occurs very infrequently o Ex. older couple tendered money to a person who was not a sales clerk ?

Did the store owner have an affirmative duty to monitor to prevent this kind of fraud o Principal Liability for Agent’s Torts (Respondeat Superior) ? If an employer-employee relationship exists, the employer is liable for all employee’s torts within the scope of her employment if: • The kind she is authorized to perform is incidental thereto • Incidental if: o Serves employer o Commonly done o Within authorized time and space o Consistent with past practice o Instrument of harm furnished by P ? Importance of Scope of Employment • P generally not liable if A acted outside the scope of the relationship. o Even if A acts outside of the scope, P may still be liable: ? P’s intent, P’s negligence, or reliance by 3rd parties on “apparent” scope.

? For torts involving people/property, Ps usually don’t authorize A to injure people or property. • P is not liable if A causes physical injury under merely apparent authority. • P is liable if employee, and within the scope of employment, causes injury. o An employee is an agent whom P controls or has the right to control the manner and means of the A’s performance of work. ? Idea: the more control (potential or actual), the more likely that acts of an employee can be ascribed to an employer. o An employee acts within the scope of employment when performing work assigned by the er or engaging in a course of conduct subject to the er’s control.

An ee’s act is not within the scope of employment (frolic and detour) when it occurs w/in an independent course of conduct not intended by the ee to serve any purpose of the employer. • Fisher v. Townsend (101) – (Vicarious Liability) o Facts: P Fisher, was badly injured in auto accident, is suing driver and alleged employer of driver. Driver drove injured home from work in back of pickup truck with no seatbelts. Driver collides with telephone pole, and injures guy. Alleged employer argues that, contractually, the driver was an only an independent contractor, so he cannot be held vicariously liable. o The facts, not the terms of the contract, determine if an agency relationship exists.

To determine whether a person who acts for another is an employee or an independent contractor, use the following factors: ? Extent of P’s control ? Whether A has distinction business ? Trade practice of supervision in locality ? Skill required of the A ? Who provides supplies ? Length of employment ? Method of payment (by job or by time) ? Whether work is part of regular er’s business ? Whether parties believe creating an agency relationship ? Whether P is in business | |Supervisor’s Control |Inferior’s Discretion | |Agents: | | | |Employees |“physical” |Inadequate | |IC’s |“general” |Considerable | |Nonagents: | | | |IC’s |minimal |Great; subject to K | o Liability of a Third Party to the Principal.

Contractual liability is reciprocal. If a P is liable on contract to a TP, then the P can likewise enforce the contract against a TP as though the contract had been made directly by the P. ? Exceptions: • If A or P knows the TP will not deal with P, then o TP is not liable when the A has falsely represented that she is not acting for the specific P. o TP is not liable when A failed to disclose the P. • However, if neither A nor P knows that TP will not deal with the P, then o TP is liable when A either misrepresents or fails to disclose the P. o Who is Liable? ? Contract • Disclosed P TP knows who the P is. o P and TP are liable, but A is not • Undisclosed P.

Different here b/c TP has no idea that A is dealing on behalf of a P o All three parties are liable, as long as there is actual authority, o Exception: Unless the K expressly excludes the P (split of jurisdiction regarding whether you can exclude a category or must it be a specific entity) • Unidentified P TP knows or suspects that A represents someone else, but A won’t tell. o All three parties are liable to the contract, b/c agent not disclosing. ?

Ex. you are selling your house, and real estate agent offers to purchase on behalf of his client. ? You may ask, and they don’t tell. o P is unidentified when the TP has notice that the A is acting for a P but does not have notice of the P’s identity. o Liability on the contract is the cost that an agent pays for not disclosing. o The agent signs on behalf of the P o TP has notice there is one o If P is entity instead of individual, then liability depends on quantum of info about P ?

Benjamin Plumbing (105) – Agent’s Liability on Contract • Facts: TP family plumbing business, is suing A for RHN, Inc. , for failure to pay on a contract. A approached TP to purchase some plumbing work on a canning project for Response to Hunger Network. P incurred $10,600 in bills, but only paid $5,000. • Issue: Whether A is personally liable on the contract with TP? Yes • If the party knows the agent is contracting for a corporation, the agent would not be liable on the contract unless she expressly assumed such liability. The fact that the agent might also be a director or officer of the corporation is generally irrelevant under agency principles.

Thus, if an agent fails to properly disclose P’s corporate status, then agent may be personally liable. The failure to use the “Inc. ” in correspondence is often critical in determining adequate disclosure. The contracting party has no affirmative duty to investigate the business ownership record of another principal. The fact that an entity is a nonprofit organization does not lead to the inference that it was a corporation. ? Tort • P liable in tort when employee acting w/in the scope of employment • P not liable if tortfeasor is an independent contractor. o Exceptions: ? P authorized tort (ex. P authorizes A to hit anyone who walks in the door) ? Tort strongly related to the agency ?

Certain duties are nondelegable (ex. accident occurs on your land, the law will presume that you have a duty to monitor, even though an IC, or any activity considered inherently dangerous, is nondelegable, like dynamite) ? Negligent hiring or supervision (ex. direct negligence liability through the P) THE INCORPORATION PROCESS • Promoter Liability ? Promoter(s): the person or persons organizing the corporation ? Owes fiduciary obligation to corporation she promotes • Duty of Loyalty (render information; not to compete; not to act as adverse party without consent) • Duty of Care ? Liability • Default rule: Promoters are personally liable on contracts.

• If contract in corporation’s name and is validly formed, then no personal liability. • If contract in promoter’s name without referring to yet-to-be-formed corporation, personally liable. • If contract in corporation’s name and promoter knows not formed, personally liable. • Law provides mechanics for shifting liability: o Novation – separate contract releasing one party for another ? Must clearly intend new contract ? Clearly new contract intended to disregard old contract ? Must be new consideration In general, a substitution of performance in exchange for release of liability is acceptable consideration. o Include in the initial contract language ?

Promoter is not personally liable on a contract made prior to incorporation which is made in the name and solely on the credit of the future corporation. • Then corporation must adopt the contract specifically. This will release the promoter from liability. • NO additional consideration is necessary • Moneywatch v. Wilbers o Facts: He signed a contract as “Jeff Wilbers, dba Golfing Adventures. ” No indication that he was signing for a limited liability entity. Moneywatch said that he was personally liable, not the new corporation. He thought he would be immune from personal liability b/c when he formed the cor