2024 Corporations! PDF

1. Introduction (Day 1)​ 2 2. The Law of Agency​ 2 A. AGENT V. INDEPENDENT CONTRACTOR (i.e. are you liable for your...

1. Introduction (Day 1)​ 2 2. The Law of Agency​ 2 A. AGENT V. INDEPENDENT CONTRACTOR (i.e. are you liable for your subordinate)​ 2 1. Actual agency relationship (express or implied)​ 2 Gay Jenson Farms Co. v. Cargill, Inc. (Minn. 1981) []​ 2 Humble Oil & Refining Co. v. Martin (TX, 1949) [tort liability]​ 3 Hoover v. Sun Oil Co. (Sunoco) (DE, 1965) [tort liability]​ 5 2. Apparent Agency Relationship​ 6 Miller v. McDonald’s (Ore. App., 1977)​ 6 3. Inherent Agency Relationship​ 7 Watteau v. Fenwick (Q.B., 1892)​ 7 B. FIDUCIARY OBLIGATION OF AGENTS​ 8 1. Duties During Agency Relationship:​ 8 General Automotive v. Singer (Wis., 1963)​ 8 2. Duties After Agency Relationship Terminates:​ 8 Town & Country House Service v. Newberry (N.Y. 1958)​ 8 3. Partnerships​ 9 A. PARTNERSHIPS V. CORPORATIONS​ 9 B. FIDUCIARY OBLIGATIONS OF PARTNERS​ 10 1. Duty to current partners​ 10 Day v. Sidley & Austin (USDC DC, 1975) [duty to current partners]​ 10 Meinhard v. Salmon (NY CoA, 1928) [heightened duty of managing partners]​ 12 2. Duties of departing partners/at dissolution​ 13 Meehan v. Shaughnessy (Supreme Court of MA, 1989) [duties of departing partners]​ 13 Page v. Page (Supreme Court of CA, 1961) [right to dissolve partnership]​ 15 4. Limited Liability​ 15 Walkovszky v. Carlton (CoA NY, 1966)​ 16 Sea-Land Services, Inc. v. Pepper Source (7th Cir., 1991) [IL veil-piercing test]​ 17 In re Silicone Gel Breast Implants Products Liability Litigation (AL, 1995) [veil-piercing to parent corp.]​ 18 Frigidaire Sales Corp. v. Union Properties, Inc. (WA, 1977) [veil-piercing in limited partnerships]​21 PRES v. Michaelson, Inc. (VA, 2014) [VA veil-piercing test]​ 22 5. Derivative Litigation​ 23 A. DIRECT V. DERIVATIVE ACTIONS​ 23 Eisenberg v. Flying Tiger Line, Inc. (2nd Cir., 1971) [derivative v. direct]​ 24 B. THE DEMAND REQUIREMENT​ 25 Grimes v. Donald & DSC Corporation (DE, 1996) [DE approach: demand futility]​ 26 Marx v. Akers (NY, 1996) [NY approach: demand futility]​ 27 C. SPECIAL LITIGATION COMMITTEES​ 28 Auerbach v. Bennett (NY, 1979) [NY approach: Special Litigation Committees]​ 28 Zapata Corporation v. Maldonado (DE, 1981) [DE approach: Special Litigation Committees]​ 29 In re Oracle Derivative Litigation (DE, 2003)​ 30 D. DERIVATIVE SUIT DECISION TREE​ 30 1  1. Introduction (Day 1) 2. The Law of Agency A. AGENT V. INDEPENDENT CONTRACTOR (i.e. are you liable for your subordinate) ​ Agency - a fiduciary relationship arises when a principal manifests consent to authorize an agent to act on his behalf and subject to his control. ○​ RSS of Agency §14(K) Comment A - creditor becomes a principal when he assumes de facto control over the conduct of his debtor → a principal may be liable for the acts of the debtor in connection with the business ○​ RSS of Agency §14(O) - One who contracts to acquire property from a third party and convey it to another is an agent only if it is agreed that he is to act primarily for the benefit of the other and not for himself. Factors indicating that one is a supplier (independent contractor), rather than an agent: ​ He is to receive a fixed price for the property irrespective of price paid by him ​ He acts in his own name and receives title to the property he is to transfer ​ He has an independent business in buying and selling similar property ​ 3 Types of Authority: ○​ 1) Actual Authority - Principal tells the agent to do something. ​ Express: What has been directly stated. ​ Implied: what is reasonable in order to carry out express authority. ○​ (2) Apparent Authority - represent agency relationship to a third party (creates liability w/r/t claims by that third party) ○​ (3) Inherent Agency Power - In some circumstances, an undisclosed principal will be liable for the acts of his agent [actions of the agent “usually within the authority given to such an agent”] ​ Prevents principals (often undisclosed) & agents from colluding and screwing 3d parties ​ Comment b to §8: The manifestation of the principal may be made directly through a third person or may be made to a community by signs or advertising authorizing the agent to state that he is authorized. ​ There is no reason to think that inherent agency power would not apply in the case of disclosed principals. ​ Criticism: This represents a windfall to whoever the assistant contracted with, because the result is different from how the contract was perceived by the third party. ​ Rationale: Inherent agency power reflects the underlying sense that principals should pay for torts or contractual breaches of their agents. 1. Actual agency relationship (express or implied) ​ The ultimate question: how much control does party have over the other’s conduct ○​ KK: the most important factor is the ability of the parties to cancel the contract!​ ​ In Humble, the contract was terminable at will and only by Humble. Schneider had no ability to cancel the contract, and therefore Humble could control his behavior. ​ In Sun, the contract was terminable by either party. If Sun tried to control Barone, Barone could simply cancel the contract. ​ True ownership revealed by: ○​ Residual profits (see flexible-rent) ○​ Residual control (see who can terminate contract) Gay Jenson Farms Co. v. Cargill, Inc. (Minn. 1981) [actual agency; control over operations] [contract] Issue ​ Whether Warren bought grain from the farmers and sold it to Cargill, or whether Warren bought grain as an agent for Cargill Facts ​ Warren (grain company) and Cargill (financer) entered into an agreement whereby Cargill would loan money to Warren, and Warren’s proceeds would be credited to Cargill’s account: 2  ​ In exchange for Cargill’s loans: ○​ Warren would provide Cargill with annual financial statements, ○​ Cargill would keep the books for Warren or an audit would be conducted by an independent firm ○​ Cargill was given right of access to Warren’s books for inspection ○​ Warren could not make improvements over $5k without Cargill’s approval ○​ Cargill must consent before Waren could declare a dividend or sell/purchase stock ○​ Warren would be reminded periodically to make the improvements recommended by Cargill ​ Cargill put in internal memo that “Warren needs very strong paternal guidance” ​ Farmers who contracted w/ Warren were paid by Cargill ​ Warren used Cargill packaging ​ Warren used Cargill’s business forms ​ Cargill kept increasing Warren’s credit line even when clearly not profitable ​ Cargill had right of first refusal to Warren’s grain ○​ Warren shipped 90% of its grain to Cargill ​ Cargill told Warren that a regional manager would be working with Warren on a day-to-day basis as well as in monthly planning meetings ​ Cargill kept a daily debit position on Warren ​ Bank account opened in Warren’s name but funded by Cargill ​ In the final days of Cargill’s operation, Cargill sent an official to supervise Warren’s operations Rule ​ A creditor who assumes control of his debtor’s business may become liable as a principal for the acts of the debtor in connection with the business (RSS Agency 14K) ​ What’s the goal of financing: Cargill’s financing of Warren was not to make money as a lender, but rather, to establish a source of market grain for its business (differentiated from a creditor-debtor relationship) ​ Degree of Control: The court focuses on Cargill’s control over Warren, citing factors such as: ○​ (1) Cargill’s constant recommendations + directing Warren to implement its recommendations ○​ (2) Cargill’s right of first refusal on grain. ○​ (3) The requirement of Cargill’s approval before Warren could enter into mortgages, purchase stock or pay dividends. ○​ (4) Cargill’s right of entry onto Warren’s premises to carry on checks and audits. ○​ (5) Cargill’s financing of all Warren’s purchases of grain and the power to discontinue. ○​ (6) Cargill’s name was printed on drafts and forms used by Warren. ○​ (7) Provisions of drafts and forms to Warren, upon which Cargill’s name was imprinted ○​ (8) Financing Warren’s purchases of grain and operating expenses ○​ (9) Cargill’s power to discontinue the financing of Warren’s operations ​ Fact-intensive inquiry: Court recognizes that many of these factors can be indicative of a sophisticated lender-debtor relationship, BUT must consider all factors together in context KK ​ Most of these factors are consistent with the usual creditor/debtor relationship. Humble Oil & Refining Co. v. Martin (TX, 1949) [actual agency; control over operations] [tort] Issue ​ Whether the relationship between Humble and Schneider is that of master and servant, such that Humble is liable for Schneider’s actions within a reasonable scope of employment 3 Facts ​ Humble Oil Co (now Exxon) (owns the filling station) → Schneider (leases & operates the filling station) → Manis (filling station employee). Car rolled down hill and hit family in their front yard. ​ Facts Against an Agency Relationship: ○​ Neither Humble, Schneider, nor the station employees considered Humble as the employer or master ○​ The station employees were paid and directed by Schneider as their “boss” ○​ Agreement expressly rejects any authority of Humble over the station’s employees ​ Facts Supporting an Agency Relationship: ○​ Contract provision requires Schneider to make reports and perform duties in connection with the operation of the station ○​ Humble provided the station building and equipment ○​ Schneider was terminable at-will by Humble ○​ Humble required to pay 75% of major operational expenses ○​ Humble controlled hours of operation ○​ Retail marketing of Humble products, which remained Humble’s property until the product was delivered to the consumer ○​ Humble maintained most business control (Schneider only hired, paid, and fired employees) ○​ Gas station looks like a Humble gas station ○​ Variable rent payment based on revenue (the more Schneider sold → the more rent he paid) (fully-flexible rent payment) Rule ​ A principal-agent relationship exists when a franchisor has the power to control the franchisee’s operation of the business/ the manner in which Schneider performs his job ​ Function > Form: Formal indicia of control can be overcome by practical indicia of control (bc formal indicia of control can be manipulated) ○​ Formal indicia of (non)control: the agreement expressly rejects any authority of Humble over the station’s employees ○​ Practical indicia of control: at-will employment and required reporting ​ Residual profits can be a proxy for practical control ​ Main factors showing agency relationship: ○​ Humble held title to the property and equipment; ○​ Humble was responsible for advertising media, products, and a substantial portion of Schneider’s operating costs. ○​ The rent was variable according to the amount of Humble product that Schneider sold in a given month. ○​ Humble set the hours of operation and could require duties of Schneider at any time. ○​ Schneider’s only real power was to hire and fire workers ​ Holding: Humble had sufficient control over the filling station to constitute an agency relationship ​ Distinguished from The Texas Company v. Wheat - where the filling station operator purchased products from his landlord and sold at his own price/terms and also sold products from other oil companies KK ​ Wants to know how large the repair business was in relation to the gas business, because it is not so obvious that Humble had control over the repair business. It is possible that the 2 businesses are separable. ​ Ordinary indicia of control are easy to manipulate. Instead of just looking at control, the court is using the financial relationship as a proxy for whether or not there is control. The court infers control from the financial relationship bc the “variable rent” looks more like an equity payment. (Day 1: residual cash flow and residual control) 4 Hoover v. Sun Oil Co. (Sunoco) (DE, 1965) [~actual agency; ~control over operations] [tort] Issue ​ Whether Barone was an independent contractor or a servant of Sun Oil Facts ​ Sunoco (owns gas station) → Barone (leases & operates gas station) → Smilyk (gas station employee) ​ Fire bc Smilyk was smoking while filling up the car ​ Facts Against Agency Relationship ○​ The lease was subject to termination by either party ○​ Sun and Barone had an agreement for Barone to purchase petroleum products from Sun and Sun was to loan equipment and advertising materials ○​ Barone was permitted to sell competitive products in certain areas ○​ Barone was not obligated to follow Sun’s suggestions ○​ Barone made no written reports to Sun ○​ Barone independently set hours of operation, hired employees, and determined their pay scale ○​ Barone’s name was posted as proprietor ​ Facts supporting agency relationship ○​ The station and almost all of its equipment was owned by Sunoco ○​ Barone promised to only sell Sun’s products in some areas ○​ Rent price was partially determined by the volume of gasoline purchased (but also min/max rent) (semi-flexible rent payment) ○​ Advertising in the telephone book was under a Sunoco heading ○​ Station employees wore uniforms with the Sunoco emblem ○​ Weekly visits from Sun to inspect the station and make suggestions (not required to follow) ○​ Barone had gone to Sun training school Rule ​ The correct test for determining whether a lessee is an independent contractor or agent (employee) is whether the owner has retained the right to control details of day-to-day operation of the station ○​ Results v. Methods: Control or influence over results alone is insufficient ​ Holding: the relationship here is landlord-tenant and independent contractor ​ The areas of close contact between Sunoco and Barone stem from the fact that both have a mutual interest in the sale of Sun products and in the success of Barone’s business ​ Ceiling on residual profits: Distinguished from flexible rent contracts in Humble bc min & max (i.e. Hoover cannot reap all residual profits) KK ​ The court is sophisticated. Even though it says the outcome turns on control, the court looks to the financial relationship as a proxy for control. The rent is variable, as in Humble, but “there was also a minimum and a maximum monthly rental,” so it looks less like a residual claim. Also, Barone alone assumed the overall risk of profit or loss. ​ Humble or Sun should try to create the appearance that the station operators are independent contractors. However, there is a public policy concern w independent contractor status and “fly by night owners” who might be underinsured. Comparing Humble and Sunoco Humble Sunoco Conventional 1. Reports: written reports required 1. Reports: written reports NOT Indicators of 2. Hour of Opp: operating hours required Operating Control controlled by Humble 2. Hour of Opps: operating hours [Naïve] 3. Appearance: looked like a Humble controlled by station operator station 3. Appearance: looked like Sun station 5  Financial Rights as a 1. Variable Rent Agreement: 1. Variable Rent Agreement: Proxy for Operating fully-flexible rent contract semi-flexible rent contract Control [Sophisticated] 2. Competitive Allowance: 2. Competitive Allowance: Barone 3. Utility Bills: Humble was responsible was given rebates on his orders to for the payment of 75% of the utility enable him to meet local price bills competition 3. Utility Bills: ???? *Competitive Allowance: If an oil company gives its station operators a rebate on its products so that the customer can meet local price competition, the oil company smoothes over the station operator’s income stream. This shifts the risk (and costs) of competition to the oil company. *Utility Bills: If costs are likely to fluctuate, then whoever is paying the bills is bearing the risk, and thus has control. 2. Apparent Agency Relationship Even if fail on agency relationship test - if appearance might still succeed under apparent authority Miller v. McDonald’s (Ore. App., 1977) [actual & apparent agency] [tort] Issue ​ Whether there was sufficient evidence that 3K (franchise) was the actual or apparent agent of McDonald’s (franchisor) Facts ​ Miller was injured when bit into a saphire while eating at 3K’s McDonald’s franchise. ​ Miller went to restaurant under assumption that McDonalds owned, controlled, and managed it (i.e. relied on restaurant’s appearance); she went for ‘the McDonald’s experience’ ​ 3K owned and operated the restaurant under a License Agreement that required it to operate in a manner consistent w the “McDonald’s System” ○​ Manuals contained detailed info relating to operation including: ​ Food formulas ​ Methods of inventory control ​ Bookkeeping procedures ​ Business practices ○​ Only use advertising and promo materials that McDonalds provided or approved in advance in writing ○​ Only only serve food and beverages that McDonalds designated ○​ Follow McDonald’s blueprints/layouts for the restaurant and adopt any reasonable changes that McDonalds made ○​ Could not make any changes in basic design of the building without McDonald’s approval ○​ Maintain the restaurant in compliance with McDonald’s standards ○​ Hours of operation set by McDonalds ○​ Had to keep appearance similar to all other McDonald's restaurants ​ Employees had to wear McDonalds uniforms ​ Could only use containers w McDonalds logos ○​ To open franchise, must have previously worked at another McDonalds location ○​ Regular inspections - failure to comply could result in loss of franchise ​ Agreement provided that 3K was an independent contractor, not an agent of McDonalds, and therefore not liable for any claims resulting from the operation of the restaurant Rule ​ Actual agency relationship: YES bc controlled daily operations ○​ Control over results v. methods: control over methods more likely to create agency relationship than just mandating certain results; manual for operations distinguished from former case where franchisor “required only that mechanical work be done in a workmanlike manner” 6  ○​ Evidence that D had the right to control 3K’s methods in the precise part of its business that allegedly resulted in P’s injuries ​ Apparent agency relationship: YES bc required uniform operations and appearance across all locations ○​ Assess appearance from POV of average customer, not a business expert KK ​ Part of business that actually caused harm: supports KK’s separate business theory ​ Even though the contract stipulates that 3K is not McDonald’s agent, it is way too formalistic and is an obvious attempt at collusion between 3K and McDonald’s to screw over customers. ​ What is the financial relationship? Reputation is McDonald’s primary product, and that is what it is really investing in each restaurant. McDonald’s is making a huge investment, so it obviously wants to have some control. To that extent, McDonald’s is actually a residual claimant because it can be badly hurt if a restaurant fails to adhere to McDonald’s reputation for quality. ​ Financial proxy notion: McDonald’s is the residual claimant for profits if a franchisee trashes their reputation, ALL McDonald’s restaurants (franchised or not), will suffer; McDonald’s, therefore, has CONTROL in the franchisor/franchisee relationship ​ Principals should be liable where their brand name induced customers to transact with agent Themes ​ The centrally imposed uniformity is the fundamental basis for the courts’ conclusion that there was an issue of fact whether franchisor held out franchisee as an agent 3. Inherent Agency Relationship ​ RSS Agency § 195. Acts of Manager Appearing to be Owner - An undisclosed principal who entrusts an agent with the management of his business is subject to liability to third persons with whom the agent enters into transactions usual in such business and on the principal’s account, although contrary to the directions of the principal. ​ Policy: Silent or Undisclosed Partners ○​ The inherent agency rule is desirable because don’t want undisclosed principals to collude with agents and cheat third parties and avoid liability. ○​ Why did Watteau leave Humble’s name on the door? ​ Negative Motive: Watteau was trying to collude with Humble to cheat third parties and to avoid liability. ​ Goodwill Motive: Humble was popular. Watteau wanted to perpetuate brand continuity. ○​ By holding all principals liable, we create incentives for them to choose agents wisely, to evaluate them and contract with them accordingly. ​ If Watteau had evaluated Humble more closely and discovered that he was sketchy, Watteau could have charged him higher fees, or granted him a lower commission or salary. Watteau v. Fenwick (Q.B., 1892) [inherent agency power] Issue ​ Whether Watteau is liable for the debts incurred by Humble, even though those debts were for items that Watteau did not authorize? Facts ​ Humble owned and operated a popular beer house → Watteau bought Humble’s beer house, but left Humble’s name on the door and retained Humble as manager. ​ Humble agreed to buy merchandise from Watteau, but violated contract by buying cigars and Fenwick (on credit) ​ Humble leaves town without paying Fenwick → Fenwick sues Watteau as principal Rule ​ Theory of inherent agency - a principal is liable for ALL acts of an agent within the authority usually given to such an agent 7  ​ Watteau did not grant actual authority to purchase cigars ​ Watteau did hold Humble out as its agent/no apparent agency (kept quiet about ownership) ​ BUT Humble had inherent authority bc cigars are usually sold in beerhouse KK ​ Fenwick should not have recovered, because he extended credit to Humble under the impression that he could only recover against Humble. Fenwick probably charged a higher interest rate than he would have charged if he thought he could recover against Watteau as well. Allowing Fenwick to recover against Watteau therefore gives Fenwick a windfall. ​ Kordana: The result of this case is in direct conflict with Restatement (2d) of Agency, § 2.06, if the undisclosed principal has NO NOTICE of the agent’s actions then he/she is NOT LIABLE Themes ​ B. FIDUCIARY OBLIGATION OF AGENTS ​ ​Tension b/w contract law and fiduciary duty: ○​ Easterbrook POV: Fiduciary duties are nothing more than default rules in a relationship between employees and employers [but he cites nothing to support this proposition]. This is the minority rule. See Jordan v. Duff & Phelps. ○​ Cardozo POV: The fiduciary duty is a high [impossible?] bar to meet. Defendants always end up losing ○​ KK POV: The answer is somewhere in the middle. ​ Fiduciary duty is a default rule that can be contracted around ​ Damages for breach of fiduciary duty = disgorgement 1. Duties During Agency Relationship: General Automotive v. Singer (Wis., 1963) [fiduciary duty to current principal] Issue ​ Singer’s side business was a violation of his fiduciary duty as an agent of GA. ​ Whether Singer owes GA the profits he made on the side business. Facts ​ Singer worked for GA as a general manager and expert machinist. ​ Singer’s contract prohibited him from engaging in other business of a permanent nature and from disclosing to any other firm information concerning GA’s business that Singer acquired ​ For jobs that GA was unable to perform cheaply or at all, Singer would contract on the side to do the work on his own and keep the profit. ​ GA sued Singer for (1) breach of contract and (2) violation of fiduciary duty, asking for Singer’s profits to be disgorged. Rule ​ Duty of loyalty: agent must disclose all business opportunities to GA ​ The issue here is that Singer DID NOT DISCLOSE this business: ○​ This information would have been useful to GA for several reasons ​ 1. GA itself could have decided to subcontract the orders or reject them outright ​ 2. GA could have decided it needed to expand its operations ​ 3. GA might want to readjust Singer’s salary [e.g. lower his base salary] and let him take profits from subcontracting KK ​ This is an action for breach of contract. Why does the court import the idea of fiduciary duty? ○​ Under breach of contract, GA must prove expectancy damages. GA would have had to prove that it could have done the work Singer brokered on the side [what GA would have made as a sub-contractor which is hard to prove]. The damage award will probably be less than disgorgement of the money Singer pocketed. ​ Under violation of fiduciary duty, the damage award is disgorgement. 8  Themes 2. Duties After Agency Relationship Terminates: Town & Country House Service v. Newberry (N.Y. 1958) [fiduciary duty to former principal] Issue ​ Whether the defendants violated their fiduciary duties by soliciting T&C customers. Facts ​ Defendants were former employees of T&C cleaning service, who left to start their own cleaning company. ​ T&C’s clients had been gained through calling houses in certain neighborhoods, and trying to make appointments with interested customers → invested effort ​ Although defendants did not solicit customers until after they had left, they only went after T&C customers, and managed to steal 13 of them [out of around 240 total, and 35 that they contacted]. ​ T&C sued for unfair competition and sought to enjoin defendants from soliciting their clients. Rule ​ Yes. T&C expended considerable business effort and advertising in assembling the customer list. The customer list is a trade secret and taking it constituted theft. ​ No duty not to compete, but a duty to not use T&C’s info to compete against it (general advertising would have been okay) KK ​ More complicated than a simple bright line rule no stealing customer lists: industry-specific (how valuable is a particular relationship?) ○​ Doctors (e.g., psychiatrists) who move between practices can certainly take their patients with them because maintaining that relationship is valuable ○​ Ls who move between firms can take Cs with them Themes ​ Soliciting Former Clients ​ In general, fiduciary duty does not lend itself to post-employment situations. ​ Depends on type of profession: ○​ If selling legal services is the same as house-cleaning, then we would infer that lawyers cannot call up their former clients after they have left a firm. ○​ But, this is not the rule in the US. A court might distinguish between legal services and cleaning services in that: ​ Attorneys develop clients on their own as opposed to the owners of T&C developing the clients. ​ Legal services involve more of a personal relationship. This is the case for many occupations: e.g., psychiatrists, insurance services. ​ Depends on info being used: ○​ If the defendants in T&C had solicited the same clients for different services, this would not have been stealing trade secrets. ​ Best practice: It may be more efficient to create a default rule to punish the employer, and create an incentive for the employer to include a non-competition clause. If pricing is really a trade secret, you either don’t tell the maids, or you make them sign a covenant not to compete. 3. Partnerships A. PARTNERSHIPS V. CORPORATIONS ​ Characteristics of a PARTNERSHIP ○​ i. Ownership interests are NOT transferable ​ e.g. You cannot simply “buy” an ownership interest in a law firm 9  ​ Good if you want to limit entry; bad if you wanted to easily retire and leave ○​ ii. Limited Life ​ This is the default rule (so you can contract around this) ○​ iii. Unlimited Liability ​ If the partnership is in lots of debt, the partners’ personal assets may be at risk ○​ iv. Considered “Informal and Flexible” in Structure ○​ v. Pays One Level of Tax ​ Profits are attributed to the partners individually, the entity doesn’t pay taxes ​ Depending on tax rates and the ability to delay payment itself, may be preferable ​ Characteristics of a CORPORATION ○​ i. Ownership interests are transferable (e.g. buy stock) ​ Often not “easily” transferable however, esp. for closely-held corporations ​ a. Bylaws may add limitations to keep it “within the family” ○​ ii. Unlimited Life8 ​ In practice, a corporation can actually “die” or “fail” ○​ iii. Limited Liability ​ No matter what the corporation does, the SHs can only lose up to the amount they invested in the firm (stock); their homes and yachts are safe ​ BUT: a small corporation might have to contract away its limited liability ○​ iv. Considered “Formal” ○​ v. Double Taxation ​ The corporation pays taxes on profits, then SHs pay taxes on their dividends ​ Why would anyone use the corporate form? ​ Historically, the personal income tax was HIGHER than the corporate tax rate – better to leave $ in the corporation; hire family members and pay salaries (instead of any dividends) ​ But see Accumulated Earnings Tax: a penalty for accumulating earnings ​ Partnership-Corporation Hybrid Forms ○​ i. Limited Liability Partnership limits the personal liability of partners with only one ○​ level of taxation ​ Some partners can have limited liability, but there must be at least one general partner with unlimited liability ​ See Frigidaire Sales Corp. v. Union Properties for an example ○​ ii. Limited Liability Company corporation that combines limited liability with partnership-style taxation ○​ iii. Business Trust ○​ iv. S Corporation state corporation that’s taxed as a partnership ​ Limits: 1 class of stock; limited number of SHs allowed; domestic SHs only ​ Formal differences between partnerships and corporations: Partnership Corporation Pros Informal and flexible structure Limited liability Easier to form (low legal costs) Free transferability of shares Single taxation Infinite life Cons Unlimited liability Formal structure (DGCL §§ 102, 109) Restricted transferability of shares Complex to form (high legal costs) Finite life (UPA §31(4)) Double taxation ​ In reality, non-tax differences can be contracted around: ○​ o (1) Limited liability is not necessarily more advantageous than unlimited liability. ○​ ​ A small corporation might have to contract away its limited liability for bankruptcy. 10  ○​ ​ On the other hand, if you think your business is going to be committing torts, limited liability is definitely much more advantageous. ○​ o (3) The limited life of a partnership is merely a default rule that we can easily contract around. ○​ ​ Partnerships can contract in advance for a new partnership when the old one dissolves. ○​ o (2) & (4) There is also a trade-off between corporation and partnership in terms of transferability and structure, which are default rules as well. ○​ ​ In reality, these factors apply only to corporations with publicly trade shares, because small firms [closely held corporations] may not offer transferability and standardization. ○​ · ​ But, shareholders often draft stock repurchase agreements [if X happens, then the shareholder can sell shares back at price Y]. ○​ ​ The default rule for partnerships requires unanimous vote of existing partners to admit new partners. ○​ ​ Bylaws of corporations may limit transferability of stock in order to keep control of a corporation in the family. ○​ o Incorporation incurs additional fees, such as the annual costs of preparing the minutes of corporate board-meetings, but these costs are necessary in order to maintain limited liability. ○​ ​ S Corporations: Don’t pay taxes; like partnerships, individuals have to include their share of the corporate income on their individual tax returns. ○​ Advantage of S corporations and partnerships is that new entities usually lose money, so the individuals receive the tax deduction. ○​ Disadvantage is that some states are predatory on people’s choice of business form, e.g., in CA, doctors were forming corporations to pay less taxes, so CA just increased the corporate tax. ○​ Restrictions: (1) Limited to 1 class of stock, (2) Limited number of shareholders, (3) Foreigners cannot be shareholders, because the federal government cannot get individual income of US tax return. ​ Limited Liability Partnership & Limited Liability Company: Entities established under State laws that confer limited liability with the benefit of the partnership tax structure. ○​ E.g., Delaware Business Trust. ○​ Flexible and permissive form created as a result of the federal tax law. ○​ Not much case law; courts look to the law of corporations to govern. UNIFORM PARTNERSHIP ACT (1914) §§ 6, 7, 9, 14, 15, 16, 18. UPA 6.1 - can become partners based on conduct UNIFORM PARTNERSHIP ACT (1997) (AKA “RUPA) §§ 103, 202, 301, 305, 308, 401. B. FIDUCIARY OBLIGATIONS OF PARTNERS 1. Duty to current partners Meinhard v. Salmon (NY CoA, 1928) [fiduciary duty of partners & heightened duty of managing partners] Issue ​ What fiduciary duty does a managing partner owe his partner regarding prospective extensions of the venture to occur after the partnership was set to expire? Facts ​ Salmon (managing partner) entered into a 20 yr lease from LL (partnership to last those 20 yrs) ​ sought to convert the hotel into shops and offices ($200k reconstruction cost) ​ Salmon & Meinhard entered into joint venture: 11  ○​ Salmon = managing partner (sole power to manage, lease, underlet, and operate the building) ○​ Meinhard = passive partner (providing ½ of reconstruction funds) ○​ Salmon pays Meinhard 40% of net profits for the first 5 years and 50% for the following years ○​ Losses borne equally among Salmon and Meinhard ○​ Certain pre-emptive rights in the case of death ​ Towards the end of the 20 yrs, LL executed new lease with Salmon, Salmon did not inform Meinhard ​ Meinhard demanded that the lease be held in trust as an asset of the venture (said he would also share the costs) Rule ​ “Joint adventurers” (copartners), owe to one another, while the enterprise continues, a fiduciary duty ○​ Fiduciary duty = One partner cannot use their share of power/opportunity in the partnership for their personal gain ​ Managing partners are subject to a heightened fiduciary duty ​ High Meinhard: “the duty of the finest loyalty”; fiduciary duties are mandatory ​ Salmon and Meinhard were partners bc: equal share in profits and losses ​ Salmon subject to higher fiduciary duty than Meinhard bc as managing partner: Salmon was in control with exclusive powers of direction (greater access to info and lease negotiations) ​ The opportunity for the second lease arose from the first lease (the joint venture) ○​ Might not be duty if clearly separate from first joint venture (i.e. if LL offered Meinhard a lease for a property far away from the original property) ​ Salmon must at least inform Meinhard of lease to give him the opportunity to compete ​ Remedy: give Meinhard percentage of shares that still preserves dominion of managing partner Salmon ○​ The additional share enables Salmon to retain control and management of the Midpoint property, which according to the terms of the joint venture Salmon was to have for the entire length of that joint venture. ​ Default rule: a conveyance by a partner of his interest does not itself dissolve the partnership arrangement absent an agreement Dissent ​ Fiduciary duties exist within the scope of that joint enterprise, but this new venture is outside of that scope (since it begins AFTER the original venture ends) ○​ 1. There is a time limit on the original venture for a reason S and M had fiduciary duties that were limited to 20 years; NO obligations in Year 21 ​ Fiduciary duties are default rules KK ​ This case doesn’t give us a workable standard. Cardozo’s standard is too high. It merely gives those wanting to find a fiduciary duty a good source of forceful language to back up the idea. Despite his crazy language, Cardozo gets the right result. Cardozo condemns Salmon for not disclosing information that he obtained in his capacity as a manager of the partnership venture. If Salmon had disclosed the business opportunity, he then would have been free to compete with Meinhard. He does not have to drag him along or cooperate with him. This is just like General Automotive v. Singer. ​ The strongest argument for Meinhard is that this is a partnership, governed by UPA. ○​ The case would be weaker if it had not been explicit that Salmon was the manager, because then Salmon would not have been Meinhard’s agent, and there would not be the agency intuition to penalize him for failure to inform Meinhard. ​ If Salmon and Meinhard had bargained over the scope of duties that Salmon owed to 12  Meinhard, they might have agreed on disclosure being necessary. ○​ The parties could have contracted around UPA by either creating or not creating a “take-me-along right” to the contract, but they didn’t. (but: A “take-me-along right” seems expensive for Meinhard to buy.) ○​ The more natural default rule may be that Salmon has to disclose, but they are allowed to compete. ○​ The court takes for granted that shareholders can act in their own self-interest. ○​ Shareholders of a corporation can be thought of as a partnership. ​ But, if this is the case, then why don’t shareholders owe each other a fiduciary duty? Day v. Sidley & Austin (USDC DC, 1975) [duty to current partners] Issue ​ Did the other partners engage in wrongdoing, such as fraud, breach of contract, or breach of fiduciary duty? Facts ​ Day = Sidley partner + sole chairman of Sidley’s DC office ​ As partner, he was entitled to a percentage of the firm's profits and a vote on certain firm matters. ​ The Executive Committee runs the day-to-day business of Sidley (Day is not a member) ​ The Executive Committee considered a merger with Liebman law firm, shared the merger proposal with the partners (including Day) who all approved the merger. The merger was discussed at 4 further meetings which Day did not attend. ​ The new partnership agreement was executed by all the partners (including Day) ​ Post-merger, Day was co-chairman of S&A’s DC office ​ After the merger took effect, Day resigned bc the new co-chairman was annoying - then sues Sidley for fraud and breach of fiduciary duty Rule UPA § 20: Duty of partners to render information Partners shall render on demand true and full information of all things affecting the partnership to any partner or the legal representative of any deceased partner or partner under legal disability. ​ Essence of a breach of fiduciary duty = (1) is that one partner has advantaged himself (2) at the expense of the firm (not at the expense of an individual partner) ​ Partners have a duty to disclose info to other partners of all info that may be of value to the partnership as a whole ​ The basic fiduciary duties are: ○​ 1. Can’t profit at expense of the partnership ○​ 2. Can’t acquire a partnership asset or divert a partnership opportunity to personal use, without consent of all partners ○​ 3. Can’t compete with the partnership within the scope of the business ​ Day LOSES because what the EC has the power to give, it can take away; the Partnership Agreement GOVERNS ​ Not fraud bc he had no right to be sole chairman ○​ 4 Elements of Fraud: ​ 1. A deliberate misstatement of fact ​ 2. Made with the intent to deceive ​ 3. Reasonably relied upon by the deceived person ​ Unreasonable to believe no structural changes as a result of the merger ​ 4. Reliance proximately and directly results in damage to that person 13  ​ Not breach of fiduciary duty bc does not harm the partnership as a whole AND bc executive committee did not personally benefit from the co-managing partner change KK ​ Day is low meinhard (a NARROWER conception of fiduciary duty) ○​ Partners have a fiduciary duty to make a full and fair disclosure to other partners of all information that may be of value to the partnership. The key to a fiduciary duty violation is benefitting yourself at your partners’ expense. ​ The Sidley Partnership Agreement contracted for a lesser fiduciary duty. ○​ The EC has LOTS of power. The partners at S&A can vote on three things: (1) who gets promoted to partner; (2) what partners get fired; and (3) what percentage of the profits each partner gets paid ○​ S&A partnerships are very far from UPA default rules – not all partners are created equal; those on the EC are “all powerful” ○​ The Executive Committee retains agenda control. ○​ The executive committee can distribute to itself the lion’s share of the partnership’s profits. ​ “An examination of the case law on a partner’s fiduciary duties, however, reveals that courts have primarily been concerned with partners who make secret profits at the expense of the partnership.” This is a super narrow reading of Meinhard v. Salmon, but interestingly, this is exactly what happened in Meinhard, so it is still consistent. ​ The only fiduciary duty owed by the Executive Committee to the other partners is the duty not to make secret profits at the expense of the partnership; the rest is governed by the contractual terms of the partnership agreement. ​ But, so long as the EC provides good management, all of the partners benefit. ​ Day’s practical rights were not adversely affected by the merger bc Day never had the right the be sole chairman of the office (always up to EC’s discretion) ○​ Day did not lose control of the DC office post-merger, because he never really had control pre-merger [control was in fact retained by the Executive Committee]. ○​ Day could have contracted for control of the D.C. office [amend the Partnership Agreement], but there’s no obvious reason why the Executive Committee would acquiesce. ○​ Day could have demanded a seat on the Executive Committee, but the Executive Committee probably would not have acquiesced. ○​ Day could have requested a “buy-out” provision [i.e., he can leave with clients if he pays liquidated damages”], but again it is unlikely that the Executive Committee would have acquiesced. 2. Duties of departing partners/at dissolution ​ Buy-Out: Agreement that allows a partner to end his relationship with the other partners and receive a cash payment, or series of payments, or some assets of the firm, in return for his interest in the firm. ○​ Contractual mechanism that drastically reduces expensive litigation over what is a fair price [and over vague fiduciary standards]. ○​ May also be used to restrict the ability of co-owners to liquidate. ○​ Buyout agreements are important in partnerships [and corporations], since partners can force dissolution of the firm at will. ○​ If Page partners had a buy-out provision, the worst case scenario is that the defendant triggers dissolution, receives poor fair market value ruling, and then gets half. 14 Meehan v. Shaughnessy (Supreme Court of MA, 1989) [duties of departing partners] Issue ​ Whether Meehan and Boyle violated their fiduciary duties to Parker Coulter Facts Incident ​ Meehan & Boyle (partners at Parker Coulter) decided to leave the firm and solicited other lawyers to join them ​ Before informing the firm, Meehan & Boyle set up the foundations for their new firm (leased office, obtained financing, etc.) ​ Also, Boyle had instructed a defecting associate to manage cases such that they would defer payments until after the defection ○​ BUT also settled cases some appropriately during interim ​ Continued working at the firm, but Boyle took many new cases for himself and did not distribute equally amongst other attorneys ​ Meehan affirmatively denies to other PC partners that he is planning to leave ​ After giving the firm notice, they send pre-prepared form letters on PC letterhead to their clients notifying them of the separation and soliciting their business. ​ Parker Coulter asked for a list of clients that Meehan intended to take - Meehan delayed providing this list until AFTER he had spoken to most of them ​ Ultimately removed 142/350 cases Partnership Agreement ​ A departing partner can remove any case which came to the firm “through the personal effort or connection” of the partner if the partner pays a “fair charge” to the firm, following which the partner may retain all future fees ​ The old firms business is “wound up” immediately and the departing partner takes a certain amount of the unfinished business of the old firm (quick separation of the surviving practices) ​ During windup, all partners have a continuing fiduciary duty to windup for the benefit of the former partnership Rule Departed Ls are allowed to compete, but can’t harm the partnership while departing ​ Permissible pre-departure conduct: ○​ Secretly setting up new firm while still acting as partners ○​ Logistical arrangements to establish new firm, including: ​ Executing lease ​ Preparing client list ​ Obtaining financing ​ Impermissible pre-departure conduct: ○​ Acquiring consent from clients to remove cases from old firm to new firm ○​ Lying to other partners about plans to leave ○​ Communicating with clients and referring attorneys using old firm letterhead ○​ Letters to former Cs did not explain that they had the option to move to new firm or remain with PC ○​ Delaying providing partners with list of clients intended to be taken to new firm until they had secured most clients ​ The court dismisses the allegations that MBC were aggressively reassigning cases for their benefit and that they were manipulating their cases in bad faith to postpone settlement or resolution. (evidence that they had been properly concluding cases while still at PC) KK ​ Partnership agreement contacted for lesser fiduciary duty - departure tax conceived of taking C’s with L at departure ​ Client Raiding: The court suggests that a departing partner may take attractive business opportunities, so long as it’s evenhanded and the departing partner 15  does not gain an unfair advantage over the other partners. ○​ Town & Country says you can’t take the client lists, but Meehan says it’s ok to use the list in your own self interest if you do it in an even-handed manner. ​ Distinguishable: In Meehan, PC partners had previously contracted away from default rule for a lesser fiduciary duty (set up a departure tax, whereby partners could leave with their clients, if they paid liquidated damages) ​ Note: some partnerships have contracted for a higher level of fiduciary duty, by providing in the partnership agreement that partners cannot contact other partners, associates, or clients before disclosing their intention to leave to the other partners. ​ Best practice: rule-like contract provision rather than the more standard-like fiduciary duty. ​ Fair competition = okay; unfair competition = not okay Themes ​ Disclosure Page v. Page (Supreme Court of CA, 1961) [right to dissolve partnership] Issue ​ Whether the partnership was for a term or at-will. ​ Whether plaintiff was acting in bad faith, trying to freeze out the defendant. Facts ​ Page brothers are partners in a linen business. ​ Historically, the business struggled but things are looking up when an Air Force base is established in their ​ town and has a high demand for linens. ​ However, G now wants to terminate the partnership (default UPA rule, partnerships terminable “at will” because there is no explicit agreement). ​ Poorer brother claims there was an IMPLIED provision of their partnership that it was for a limited time (until the linen firm recouped its initial investment) ​ When partnerships are terminated, they are “wound up” assets liquidated and creditors paid; essentially, an auction is held and the firm is SOLD Rule Rule: A partnership may be dissolved by the express will of any partner when no definite term or particular undertaking is specified, as long as the dissolution is in good faith, and subject to the fiduciary duties owed by partners to each other. 1) Duration of partnership ​ UPA: partnership may be dissolved “by the express will of any partner when no definite term or particular undertaking is specified.” ​ Must be some evidence to find an implied agreement that a partnership would be for a specific term (e.g. “until investment recouped,” or “until it could be sold upon favorable and mutually satisfactory terms”) ○​ Mere “hope that profits would pay off expenses” is not specific enough to establish a “definite term or particular undertaking” 2) Bad faith termination ​ Even though the UPA provides that a partnership at will may be dissolved by the express will of any partner, this power still must be exercised in good faith ​ A partner at will is not bound to remain in a partnership (whether or not it is profitable) ​ However, a partner may not dissolve a partnership to gain the benefits of the business for himself unless he fully compensates his co-partner for his share of the prospective business opportunity 16  ​ Holding: remanded on Q of bad faith dissolution KK ​ Best practice: ex ante agreement that, if partnership is to be dissolved, partnership assets cannot be purchased except at a price equal to or higher than the appraised price (keeps one party from getting screwed over) ​ Interaction between contract law and fiduciary duty. ○​ Tension between contract law [“any time” means “any time”] and fiduciary duty [“any time” means “any time that doesn’t opportunistically dissolve”]. ○​ The I.O.U. is characterized as a “demand note,” which means that plaintiff’s corporation can demand payment of the debt at any time. ○​ Plaintiff’s demand will collapse the partnership, because the linen business must be sold to pay the demand note. Themes ​ Buy/Sell Agreements a. These agreements give the partners a contractual right to exit the firm by selling their shares to the other investor(s) [in exchange receiving a cash payment or series of payments] b. Essential components of a B/S Agreement i. (1) The circumstances under which you have a right to buy or sell – death, retirement, etc. ii. (2) A mechanism to determine the price at which you can buy or sell c. Possible Mechanisms i. (1) I Cut, You Choose 1. There are 3 friends: A, B, and C. If A dies, then A’s estate will set a value for the firm. B and C then decide whether they want to sell their shares to A’s estate or buy A’s shares. 2. This doesn’t work well when one party is cash constrained a. One way to mitigate this problem is by allowing the “buy” party to pay in installments over time ii. (2) Formula iii. (3) Appraisal – If either partner retires, the other has the right to buy out their shares at a price determined by an appraiser d. Kordana: You might want to “hair cut” the person who is leaving the firm because this is really irritating to the other partners (penalty) i. Therefore, instead of getting 100% FMV for your shares, you only get 90% e. Good to contract around default rules that you don’t like because it is foreseeable that partners will die or want to retire, and it’s easier to figure out what to do in advance (i.e., buy sell agreement) rather than go to court and litigate facts i. Plus, when you are faced with Traynor’s vague fiduciary duty standards – it’s better to have the clarity of a contract! f. Kordana: If you are in a publicly traded corporation, you DO NOT need a buy sell agreement because (1) Goldman Sachs is interested and following the firm; and (2) the stock market provides an easy route to buy and s 4. Limited Liability ​ Limited liability - you can only lose the amount you invest ○​ Statutory creation ○​ MBCA § 6.22(a): A purchaser from a corporation of its own shares is not liable to the corporation or its creditors with respect to the shares except to pay the consideration for which the shares were authorized to be issued or specified in the subscription agreement. ​ 3 Theories of liability: ○​ (1) Enterprise Liability [Sideways Piercing] ​ Walkovsky could reach the assets of the 9 other corporations and the garage. ○​ (2) Personal Liability on the Part of the Shareholders [Vertical Piercing] ​ Walkovsky could reach the personal assets of Carlton. ○​ (3) Respondeat Superior [Agency Law] 17  ​ Walkovsky could reach the personal assets of all of the shareholders, not just Carlton. (Courts never do this for policy reasons) ​ Piercing the corporate veil ○​ Veil-piercing is UNCOMMON – usually happens when there is lack of attention to corporate formalities ​ Piercing is even more rare in CONTRACT cases than in TORT cases. In a contract situation, circumstances are more foreseeable and provisions of the contract can be used to compensate a party that may get the short end of the stick. Tort victims do not get these benefits, and need compensation for injuries [so courts are often more sympathetic and more willing to pierce] ○​ There is an unspoken rule that we NEVER pierce the corporate veil to reach PUBLIC shareholders because we want to encourage suburban dentists to invest ○​ There are 2 general situations to look out for where a court will pierce ​ 1. Lack of Attention to Corporate Formalities/Commingling of Funds ​ Respect the SEPARATE existence of the corporation – do not use the corporate funds for personal reasons; do formal/corporate things (e.g. issue dividends, bill internally, etc.) ​ Corporate formalities will help in a contract situation MORE than in a tort victim situation ​ 2. Injustice ​ Requires MORE than just not getting paid ​ Often involves FRAUD, which is an independent ground to justify veil-piercing ​ Threat of double-dipping if pierce the veil ​ 3 Veil-Piercing Tests: ○​ 1. Illinois 2-Prong (Unity of Interest) Test (Sea-Land) ○​ 2. California Totality of the circumstances test ○​ 3. Virginia 2-Prong (Undue Domination) Test Walkovszky v. Carlton (CoA NY, 1966) Issue ​ (1) Whether Carlton is personally liable. [Can Walkovszky pierce vertically?] ​ (2) Whether the fragmented corporate structure was fraudulent Facts ​ Carlton (D) = shareholder in 10 separate taxi cab corporations ○​ Each corporation had 2 cabs registered in its name (common practice in industry) ○​ Each corporation has statutory minimum insurance for a corporation of its size (2 cabs) ○​ Only 2 cabs per corporation to be undercapitalized → worst he can lose in lawsuit is 2 cabs, the others are safe bc LL ​ Carlton’s cab injured Walkovsky (P), but corporation’s liability insurance is insufficient to cover Walkovsky’s costs, so P wants to sue Carlton personally ​ P: 10 corporations operating as a single entity w/r/t financing, supplies, repairs, employees, and garaging = fraud → D is entitled to hold stockholders personally liable (respondeat superior) Rule 1) No veil-piercing ​ Courts will pierce corporate veil when: ○​ 1. One uses control of corporation to further personal interests instead corporation’s business interests, he is responsible for the corporations acts via respondeat superior (even if agent is a natural person) 18  ○​ 2. Necessary to prevent fraud or to achieve equity ​ In determining whether liability should be extended to reach assets beyond those belonging to the corporation, courts will be guided by general rules of agency 2) Is this fraud? ​ Inadequate assets [even intentional undercapitalization] and inadequate insurance are NOT ENOUGH to warrant veil-piercing. ○​ W needed to allege specific intermingling of funds or informality that would suggest the corporations were merely a “front.” ​ Cannot pierce the corporate veil just because the assets + insurance coverage of corporation are insufficient for D to recover; If the statutory insurance coverage minimum is insufficient → legislature should fix not courts ​ Holding: ○​ ​Carlton did not commit fraud. Any small 2-cab company could have been doing the same thing, and there is no chance for misrepresentation by a cab company to a pedestrian regarding its corporate assets, size, or form. ○​ The fact that corporation may have been operating as one large corporation does not prove that Defendant was controlling the corporations for his personal benefit. Dissent ​ If a corporation is organized and carries on business without substantial capital in such a way that the corporation is likely to have no sufficient assets available to meet its debts, it is inequitable that shareholders should set up a flimsy organization to escape personal liability ○​ Policy of law that shareholders should in good faith put capital at risk for its prospective liabilities ​ D’s cab corporations were intentionally undercapitalized and drained of income to avoid liability for foreseeable torts ​ Threshold test: was there an attempt to provide adequate capitalization? ○​ An obvious inadequacy of capital, measured by the nature and magnitude of the corporate undertaking, has frequently been an important factor in cases piercing the corporate veil KK ​ This seems like a “crazy corporate law” principle (limited liability) since Carlton is only forced to internalize the cost of the accidents if we pierce the veil or the legislature raises the minimum insurance cabs are forced to have ○​ Fragmentation like this isn’t always bad – asset partitioning can help get the company better loans ○​ Under enterprise liability (sideways piercing) P would have been able to recover from all of Carlton’s companies while still respecting the shareholders ​ Different POV from contract law perspective v. tort law perspective: ○​ From a contract law perspective, we should not veil-pierce on the basis of undercapitalization, because a contract creditor should do their due diligence before lending ​ On the other hand, if veil-piercing were routine, then parties would sign contracts with that expectation. ○​ From a tort policy perspective, the result in this case is crazy. It is reasonably foreseeable that running a taxi cab will result in accidents. Tort law forces people to take cost- justified steps to reduce accidents, i.e. to internalize the costs of the accidents. Carlton is clearly manipulating corporate law to externalize perfectly foreseeable costs of accidents onto the victims. ​ If we just veil-pierce the legislature is never forced to confront the underlying problem: that the statutory minimum is too low Themes 19 Sea-Land Services, Inc. v. Pepper Source (7th Cir., 1991) [IL veil-piercing test] Issue ​ What is the correct test for piercing the corporate veil? Facts ​ Marchese owned Pepper Source and five other corporations (plus 50% of Tie-Net), which he operates informally, commingling funds and not respecting any corporate formalities. ​ Sea-Land shipped peppers for Pepper Source ​ Pepper Source owed Sea-Land $87k, but Sea-Land cannot collect from PS, because it is a shell company with no assets. ​ SL sues, trying to either (1) collect Marchese’s personal assets [vertical piercing]; (2) collect from the other corporations that Marchese owns 100% of [sideways piercing]; or (3) collect from TN, which is owned 50% by Marchese Rule ​ 2-Prong test for piercing the corporate veil: ○​ 1. There must be such a unity of interest and ownership that the separate personalities of the corporation and the individual (or other corporation) no longer exist, AND ​ Failure to maintain adequate corporate records or comply w corporate formalities ​ Commingling of funds or assets ​ Undercapitalization ​ One corporation treating the assets of another as its own ​ No corporate meetings held ○​ 2. Circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice (remanded for consideration) ​ Less than proving fraud, but MORE than simply an uncollected judgment ​ Previous cases: ​ Common sense rules of adverse possession would be undermined ​ Former partners would be permitted to skirt the legal rules concerning monetary obligations ​ A party would unjustly enriched ​ A parent corporation that caused a subsidiaries liabilities and its inability to pay for them escapes those liabilities ​ Intentional scheme to hide assets in a liability-free corporation while acquiring liabilities on an asset-free corporation ​ (1) Single unity satisfied bc: ○​ None of the corporations held meetings besides Tie-Net (Tie-net meetings had no minutes) ○​ No articles of incorporation, bylaws, or other agreements ○​ Marchese ran all corporations out of the same single office, with the same phone line, and same expense accounts ○​ Marchese “borrows” substantial sums from the corporations interest free ○​ The corporations “borrow” money from each other when need be ○​ Marchese has used corporations’ bank account to pay personal expenses ○​ Marchese did not even have a personal bank account ​ (2) Remanded for determination of second prong: On remand, the trial court finds that the second prong is met by Marchese’s tax fraud, use of corporate funds for 20  personal benefit, and his promise to Sea-Land to pay the freight bill while intending to stiff them all along. KK ​ If the prospect of an unsatisfying judgment is enough to justify veil-piercing, then every plaintiff passes on that score = which is why court does not think second prong is satisfied! ​ Court considers Tie-Net as much part of the network of corporations as the other entities which seems unfair considering the fact that Marchese owned only half the company - why should the second shareholder suffer damages due to Marchese’s wrongdoing? ○​ Solution: more effective to give S-L a 50% share in Tie-Net as damages because that would only penalize Marchese. To decide differently, court would have to prove that Andre negligently omitted to interfere with Marchese’s commingling of the funds. ​ Veil piercing should be pretty RARE [which this case illustrates] ​ Classic example where Prong 2 would be met: Kordana advertises on TV to get citizens of Charlottesville to invest in the “Kordana Bank” and buys himself a yacht. ​ The court treats TN the same as the other corps (even though Marchese only owns 50%) In re Silicone Gel Breast Implants Products Liability Litigation (AL, 1995) [veil-piercing to parent corp.] Issue ​ Is a finding of fraud or similar misconduct is necessary to pierce the corporate veil. Facts ​ Bristol = parent company of MEC ​ Facts evidencing Bristol’s control over MEC: ○​ Bristol carried out its own transactions in MEC’s name ○​ MEC board consisted of Bristol execs (some of whom didn't even know they were on the board) ​ Bristol VP could not be voted off the board ○​ No MEC board meetings ○​ MEC submitted actions for review/approval to Bristol but Bristol never objected ○​ Bristol set the employment policies and wage scales for MEC’s employees ○​ MEC required to seek Bristol’s approval for hiring MEC execs ○​ MEC execs rated on the Bristol scale ○​ Key MEC execs received Bristol stock options ○​ MEC employees could participate in Bristol’s pension and savings plans ○​ Other Bristol subsidiaries provided free services to MEC ○​ Bristol in-house counsel acted as MEC attorneys ○​ Bristol’s PR department issued statements regarding MEC’s products ○​ Bristol’s name and logo were on implant packaging ○​ Bristol’s name was used in all sales and promo communications w physicians ​ MEC ceased all operations by selling its urology division (with Bristol’s approval) and proceeds from the sale were turned over to Bristol ​ MEC now has limited assets ​ Ps sue for under agency liability, and direct liability (pierce corporate veil) Rule ​ When a corporation is so controlled as to be the alter ego or mere instrumentality of its stockholder, the corporate form may be disregarded in the interests of justice. If such control is shown → NOT required to show fraud. ○​ Must show substantial domination.Totality of the circumstances inquiry, including whether: ​ Parent and subsidiary have common directors or officers ​ Parent and subsidiary have common business departments ​ Parent and subsidiary file consolidated financial statements and tax returns ​ Parent finances subsidiary ​ Parent caused incorporation of subsidiary 21  ​ Subsidiary operates with grossly inadequate capital ​ Parent pays salaries and other expenses of subsidiary ​ Subsidiary receives no business except that given to it by parent ​ Parent uses subsidiaries property as its own ​ Daily operations of two corporations are not kept separate ​ Subsidiary does not observe basic corporate formalities (such as keeping separate books/records and holding shareholder/board meetings) ​ Parent corporation is expected/required to exert some control over its subsidiary - the issue is degree of control ​ The potential for abuse of the corporate form is greatest when the corporation is owned by a single shareholder ​ Fact-finder could find the facts support that MEC was so controlled by Bristol so as to be a mere instrumentality of Bristol bc: ○​ ⅔ MEC’s directors = Bristol directors ○​ MEC was part of Bristol Group and used Bristol’s legal, auditing, and communications departments ○​ MEC and Bristol filed consolidated federal tax returns and prepared consolidated financial reports ○​ Bristol operated as MEC’s creditor, providing loans w interest (using MEC’s resources as its own) ○​ Bristol VP could not be voted out ○​ Bristol label on MEC boxes KK ​ Seems like it should be a case of apparent authority, but the court doesn’t discuss that issue ○​ Under Walkovsky or Sea-Land the case would be too weak to pierce – normally lack of attention to formalities is a proxy for unfair conduct, but not here. ​ There were only uncompensated services by the Bristol Group to MEC (e.g. Insurance), Bristol never received any dividends from MEC and MEC prepared its own tax forms – why is it that the court found Bristol exercising a considerable control over MEC? Most importantly, there was no undercapitalization of MEC to meet the claim on its own ​ Concerning the product liability claim, why should this be more tort- than contract-related? This does not seem obvious at all! ​ Many jurisdictions that require a showing of fraud, injustice, or inequity in a contract case do not in a tort situation; here, Ps potentially contracted w Ds (but they really contracted w doctors who chose the implants) ○​ In contract case → creditor willingly did business with the subsidiary corp (assumption of risk) ○​ In tort case → injured party did not chose to do business with subsidiary corp (no assumption of risk - assuming tort ~ arise out of consensual relationship) ​ Potential claim under apparent agency liability bc put name on implant packages, issued press releases about MEC products, used name in sales communications o The lack of corporate formalities in this case actually cuts in favor of the creditors. ​ Lack of formalities left more money in MEC than it would have otherwise had. ​ MEC provided services and did not charge for it. ​ Bristol was not liquidating the assets of MEC to externalize tort costs. ​ MEC is not undercapitalized—MEC never paid a dividend to Bristol. · ​ Undercapitalization is not obviously present here, yet the court finds that it is. · ​ Therefore, undercapitalization cannot simply mean that the corporation has insufficient assets to satisfy an unfavorable judgment at the time of judgment. 22  · ​ Undercapitalization must mean that ex ante, before the tort or when the corporation was being set up, the corporation lacked sufficient assets to pay off tort claims that the corporation [not the shareholders] reasonably should have expected to occur. o We have to adopt this meaning unless we are always going to allow veil-piercing or never allow it. ​ (2) Direct Liability Theory. NO. o Tort victim can sue even without privity of contract. ​ E.g., electrician negligently wires light in hotel and guest is injured; guest can sue electrician directly for his negligence instead of only having a claim against the hotel. o But Bristol did not provide a service to MEC. ​ Bristol provided financing, marketing advice, etc. to MEC, which was not negligent. ​ The negligence occurred during the manufacturing process. ​ Counter-argument: It is per se negligent to market a defective product. ​ (3) Apparent Authority. YES. o Smoking gun is the fact that the breast implants say “Bristol” on them, and not “MEC.” o Why didn’t the plaintiffs proceed on a theory of apparent authority? Bristol Could Have Avoided Liability By: ​ Following corporate formalities. ​ Buying insurance and paying premiums. ​ Making it more explicit that it’s relationship with MEC was contractual. ​ Taking advantage of the unwritten rule that we never pierce the veil to public shareholders. o Give MEC stock for each share of Bristol shock a shareholder owns. o Once trading occurs, there will be a different set of owners. o A spin-off such as this is a good legal solution, but it may have financial costs, because the shares of stock may have been valuable to Bristol. o Bristol also could still be susceptible to enterprise liability [sideways piercing]. Frigidaire Sales Corp. v. Union Properties, Inc. (WA, 1977) [veil-piercing in limited partnerships] Issue ​ Usually limited partnerships have limited partners [with limited liability] and a general partner [with unlimited liability]. Can we substitute a corporation for the general partner, and therefore still maintain limited liability? Facts ​ Frigidaire entered into contract lending money to Commercial Investors ​ Commercial Investors = partnership ○​ Manon and Baxter = limited partners ○​ Union Properties Corporation = general partner ​ Manon and Baxter = officers, directors, and shareholders of Union Properties Corporation ​ Controlled day-to-day operations of Union Properties Corp. ​ WA law allows parties to form limited partnerships with one corporation as its only general partner ​ Issue: liability for limited partners who control the limited partnership as officers, directors, and shareholders of the corporate general partner 23  ​ P argues that they should be able to hold Manon and Baxter liable bc they controlled day-to-day operations and management of Commercial ​ Commercial was controlled by Union Properties, a separate legal entity, and not by Manon and Baxter in their individual capacities Rule ​ Limited partners do not incur general liability for the limited partnership’s obligations simply bc they are officers, directors, or shareholders of the corporate general partner ​ Limited partners can be liable if they aren’t passive, but instead exercise active control over the corporate general partner ​ Key distinction: corporation and LLP were not created concurrently ○​ If created concurrently → suggests that the sole purpose of the corporation was to operate the partnership ​ Not the case here: Commercial was one of several partnerships that Union Properties operated ​ Reliance: P was never explicitly or impliedly led to believe that respondents were acting in any capacity other than in their corporate capacities (not personal) ○​ Coase: P could’ve contracted that Manon and Baxter personally guarantee contractual performance ​ Undercapitalization alone does not justify the finding that limited partners shall incur general liability ​ As long as a limited partner adheres to the formalities of both corporate and partnership law, the corporate veil will not be pierced. KK ​ Difference between tort and K cases: in K cases P has an opportunity in advance to investigate the financial resources of the corporation and choose whether or not to do business with them. Ps assume the risk and intend to enter into a K ​ This opinion does not preclude a finding of liability of limited partners where there is a showing of fraud or deception. ​ Some jurisdictions are less lenient in protecting limited partners if they also control the corporate general partner. ​ Some jurisdictions go further and prohibit corporations from being general partners PRES v. Michaelson, Inc. (VA, 2014) [VA veil-piercing test] Facts ​ Michaelson = president and sole shareholder of MPI (real estate corporation) ​ AAA = Partnership b/w PRES and MPI ​ In 1985 and 1986, AAA distributed its profits to PRES and to MPI. MPI then distributed its profits to Michaelson, its sole shareholder. ​ AAA gets sued and PRES pays full settlement bc MPI already issued profits to 24  Michaelson ​ PRES sued Michaelson personally Rule ​ *under VA law* P bears the burden of convincing the court to disregard the corporate form by showing: ○​ 1. The corporate entity was the alter ego, alias, stooge, or dummy of the individuals sought to be charged personally, AND ​ May be established by evidence that D exercised undue domination or control over the corporation ​ Can consider whether: ​ D observed corporate formalities ​ Kept corporate records ​ Paid dividends ​ There were other officers and directors ○​ 2. The corporation was a device or sham used to disguise wrongs, obscure fraud, or conceal crime ​ Not sufficient to be unfair or unjust - must be a legal wrong (standard in some jurisdictions) ​ The second prong of the Virginia Test for Veil-Piercing is NOT satisfied [need something MORE than collecting a debt to show injustice/fraud] ​ The parties here expressly put the issue of limited liability on the bargaining table but settled on agreement that required corporation, not individual, to answer for debts of the partnership KK ​ K agreement where one party assumed more risk should not be entitled to piercing of veil that would given them more than what they bargained for (sim to double dipping) ​ Best practice: PRES should have partnered with Michaelson personally, rather th