Business Associations Outline
I. The Nature of the Corporation
A. Promoters and the Corporate Entity
a. Southern-Gulf Marine Co. No. 9, Inc. v. Camcraft, Inc. (Did Case)
1. Pre-incorporation contracts are okay.
2. They often include a clause that transfers liability for the contract to the corporation once it is incorporated.
B. Black Letter Law:
a. At common law, There are two different ways of approaching corporations that have a flaw in their formation:
1. De facto Corporation: A court may treat a firm which is not properly incorporated as a corporation if the organizers of the firm
i. (a) in good faith try to incorporate,
ii. (b) had a legal right to do so, and
iii. (c) acted as a corporation.
2. Corporation by Estoppel: A court will treat a firm which is not properly incorporated as a corporation if a person dealing with it
i. (a) thought it was a corporation all along
ii. (b) would earn a windfall by denying its existence
3. There’s an overlap here, and what matters is the person who you’re dealing with.
i. De facto Corporation deals with what the entity itself thinks.
ii. Corporation by Estoppel deals with what people outside the corporation think in their dealings with the entity.
C. The Corporate Entity and Limited Liability
a. Walkovszky v. Carlton (taxi cabs, p. 206) – hypo re: supertankers was used in class instead of discussing the facts of this case.
1. FACTS: One person owns a bunch of corporations which each own one ship. The insurance required on each of the ships is limited to $10 million, and that’s all that J purchased. Each corporation is owned entirely by J. She runs each of the companies from one office. Each corporation is properly incorporated. J borrowed the $ to set up each of the corporations. All of the expenses of the corporations are paid for by the pre-paid lease contracts on the tankers. A tanker runs aground causing damage, and people want to sue…
2. Is this all one corporation → Two distinct issues
i. Is there intermingling of corporate assets with personal assets? (financial considerations)
ii. Are corporate formalities being observed? (formal legal considerations)
3. Piercing the Corporate Veil is one way of challenging a corporation. The other is:
i. Enterprise Liability
i. To find this, in discovery, look for:
1. separate books
2. when the corporations were founded, etc.
ii. A clincher for finding enterprise liability would be if they all shared the same checkbook. The most suspicious thing is a no-interest loan from the company to the owner-operator or from one company to another. It’s even more suspicious when the loan never gets paid back.
4. To preserve limited liability for a corporation, essentially, all you have to do is observe the formalities. Generally, the failure to do that is the first indication that something is going wrong.
5. The protective buffer created by a limited liability corporation gives investors the ability/incentive to take the risk of embarking on the corporate venture – the person can lose the amount they invested instead of fearing losing everything he/she has.
b. Sea-Land Services, Inc. v. Pepper Source (7th Cir. 1991) p. 211
1. Facts: Sea-Land is an ocean carrier who agreed to ship peppers for Pepper Source. PS did not pay the bill. A trial court ruled that PS had to pay SL damages, but prior to the ruling, PS was dissolved and SL was unable to collect the judgment. SL then went after Marchese, who was the owner of PS, and the other 5 businesses that he owns.
2. In a nutshell:
i. Sea-Land wants to pierce the corporate veil to get at Marchese. From Marchese, SL wants to pierce the veil to get to Marchese’s 5 companies.
3. Marchese’s 5 companies had:
i. No bylaws, No meetings of directors, No shareholders, Never held a corporate meeting (except for Tie Net), No minutes for any meetings, No separate books or bank accounts, Marchese was paying all of his personal bills from the business accounts and had no personal accounts.
4. HOLDING: No veil piercing – facts don’t meet prong 2 of the Van Dorn Test.
i. In IL, to pierce the corporate veil Van Dorn requires
i. a shared unity of interest and ownership that the separate personalities of the corporation and the individual no longer exist (requires corporate formalities exist to protect against piercing)
ii. (2) circumstances must be such that adherence to the fiction of separate corporate existence would sanction a fraud or promote injustice.
ii. NOTE: All circuits in the country have differing required criteria for piercing the veil.
c. Kinney Shoe v. Polan (get notes—called on)
d. In re Silicone Gel Breast Implants Products Liability Litigation (N.D. Ala. 1995)
1. Facts: Bristol-Meyers Squibb Co. (Bristol) is the sole shareholder of Medical Engineering Corporation (MEC). They are separate legal entities. MEC makes breast implants, and there were problems with the implants. Nationwide πs suing MEC want to get at Bristol’s $$.
2. Since there are πs in every state, the court applies the law that all jurisdicitons have in common:
i. A showing of substantial domination (that Bristol controlled MEC to the point where they are really intermingled—substantial domination is another term for unity of interests, etc.)
3. Bristol and MEC are intermingled, but the corporate question is: is Bristol exploiting MEC?
i. MEC is benefiting from Bristol. The only exploitation by Bristol seems to be the interest on MEC’s money going to Bristol (with the question being does the interest pay for the services that Bristol gives MEC). For our purposes, the intermingling alone is okay to satisfy prong #1.
4. Holding: The court determined that the intermingling alone was enough to get past summary judgment.
e. Frigidaire Sales Corporation v. Union Properties, Inc. (Wash., 1977)
1. Frigidare entered into a K with Commercial Investments (CI). Mannon and Baxter are limited partners of Commercial. M&B are also officers, directors, and shareholders of Union Properties (UP), the only General Partner of Commercial. Through Union, M & B exercise day-to-day control and management of Commercial. Infinite liability in a limited partnership lies with the general partner – the infinite liability therefore lies with Union.
2. Limited partner = receives a portion of the profits for his investment but plays no role in running the corporation.
i. Your potential losses are limited to your investment.
3. General partner = manages the corporation.
i. Your potential losses are infinite.
4. Take away from this case:
i. The laws of most jurisdictions allow the general partner of a limited partnership to be a corporation.
ii. Also take away what a limited liability corporation is.
II. Shareholder Derivative Actions
a. Shareholders do not have standing to sue.
b. A derivative action is:
1. An action in equity (because the shareholder acts on behalf of the corporation).
i. B/c the corporation hasn’t taken any action, it’s named as the ∆ (Ex. CalPERS v. Tyco).
ii. The object of the lawsuit is to sue another party – usually the managers who are exploiting the company.
2. Corporate corruption clients and shareholder actions are
i. The vindication of the rights of the corporation against the managers who have either inappropriately appropriated the companies money or mismanaged the company to the detriment of the shareholders.
B. Frivilous Suits:
a. Cohen v. Beneficial Industrial Loan Corp. (1949)
1. Facts: A personal stockholder who has a trivially small percentage of shares in the company sees a possible conspiracy within the corporate structure (mismanagement and fraud exceeding $100 million) tries to bring suit. The NJ law states that he has to put up a security of $50K. The only people who have to post bonds according to the NJ law are those who have less than 5% of the aggregate of the corporation.
2. Bond Posting Requirement →The rationale for only making small shar
2. In NY, they have a slightly different set of criteria (in word, but not in practice, but DE and NY courts care about the distinction):
i. In NY, a demand would be futile if a complaint alleges with particularity that
i. (1) a majority of the directors are interested in the transaction; or
ii. (2) the directors failed to inform themselves to a degree reasonably necessary about the transaction; or
iii. (3) the directors failed to exercise their business judgment in approving the transaction.
3. Both DE and NY invoke the “reasonable doubt” standard.
D. The Role of Special Committees
a. Auerbach v. Bennett, 47 N.Y.2d 619 (NY, 1979)
1. Facts: General Telephone Company hears about how other corporations have given bribes and kickbacks to local officials domestically and in foreign companies. They then commission their own preliminary internal investigation. The auditing committee consisted of 3 directors who were not in the company at the time of the alleged wrongdoing. They then bring in Wilmer, Cutler & Pickering (a big DC firm), which had not previously been counsel to the company, and Arthur Anderson. They find $11 million in kickbacks and payoffs. They then determine that they don’t want to go through court proceedings b/c it will waste the time of senior management, cause bad publicity, etc.
2. Issue: Was the business judgment of the committee tainted in determining not to pursue litigation?
i. It was tainted, b/c the Board wasn’t disinterested and independent. Some (but not a majority) were involved in giving the bribes and the kickbacks.
b. The business judgment rule shields the deliberations and conclusions of the chosen representatives of the board only if they possess a disinterested independence and do not stand in a dual relation which prevents an unprejudicial exercise of judgment . . . .
1. DE law (and NY law) allows you to delegate Board functions to a committee of the Board (the committee can then act in the place of the Board).
2. DE law differs from NY law on special committees.
c. Zapata Corp. v. Maldonado, Del. 1981
1. Refers to Sohland v. Baker (Del.Supr. 1927) – a stockholder has an absolute right to start a lawsuit, but not to continue one.
2. Delaware has more judicial inquiry than NY in determining the independence of a special committee:
i. DE also sets up a 2-step test, and the 2nd prong is optional:
i. 1) Look at independent good faith of committee, then
ii. 2) (if the court thinks something is fishy) The court then uses its own independent business judgment to determine if the motion should be granted.
ii. This is a balancing of interests – the committee’s independent business judgment versus the court’s independent business judgment.
The goal is to prevent “instances where corporate actions meet the criteria of step one, but the result does not appear to